Deck 8: Valuation of Financial Securities

Question 1

Mega Inc. is expected to pay a dividend of $2.00 per share next year. The dividends are expected togrow at a constant rate of 5% per year indefinitely. If investors require a 12% return on Mega stock,what is the current price?

A) $32.00
B) $16.67
C) $30.00
D) $28.57

Answer 1

$28.57

Question 2

Interest rate risk and the time to maturity have a relationship that is best characterized as

A) varying.
B) inverse.
C) direct.
D) constant.

Answer 2

direct.

Question 3

Common stock in a business that was purchased for $100,000 and has a discounted cash flow value of $340,000 would be worth __________ per share in an efficient market; there are 100,000 shares outstanding.

A) $2.40
B) $3.00
C) $3.40
D) $1.00

Answer 3

$3.40

Question 4

A firm has a balance sheet common shares account with a value of $260,000. The firm has 10,000common shares outstanding. If the retained earnings account has a value of $250,000, the commonstock originally sold for

A) $30/share.
B) $25/share.
C) $24/share.
D) $26/share.

Question 5

The cost of preferred stock is

A) higher than the cost of long-term debt and lower than the cost of common stock.
B) lower than the cost of convertible long-term debt and higher than the cost of common stock.
C) higher than the cost of common stock.
D) lower than the cost of long-term debt.

Question 6

The yield to maturity on a bond with a price equal to its par value will

A) always be equal to the coupon rate.
B) be less than the coupon rate.
C) be more or less than the coupon rate depending on the required return.
D) be more than the coupon rate.

Question 7

The yield curve in an economic period of high inflation would most likely be

A) downward-sloping.
B) upward-sloping.
C) linear.
D) flat.

Question 8

__________in the beta coefficient normally causes __________in the required return and therefore __________in the price of the stock, all else remaining the same.

A) A decrease; a decrease; a decrease
B) An increase; an increase; a decrease
C) An increase; a decrease; an increase
D) An increase; an increase; an increase

Question 9

If a corporate bond is issued with a coupon rate that varies directly with the required return, theprice of the bond will

A) be greater than the face value.
B) equal the face value.
C) be less than the face value.
D) be greater than or less than the face value depending on how interest rates vary.

Question 10

Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent annual couponinterest rate. The issue has ten years remaining to the maturity date. Bonds of similar risk arecurrently selling to yield a 12 percent rate of return. The current value of each Hewitt bond is __________.

A) $1,052
B) $791
C) $1,113
D) $1,000

Question 11

The price of a bond with a fixed coupon rate and the market required return have a relationshipthat is best described as

A) direct.
B) varying.
C) constant.
D) inverse.

Question 12

Following the theory of the "efficient market hypothesis" all of the following are true EXCEPT

A) at any point in time, security prices fully reflect all public information available about the firm and its securities, and these prices react swiftly to new information.
B) since stocks are fully and fairly price, it follows that investors should not waste their time trying to find and capitalize on mispriced (under- or over-valued) securities.
C) securities are typically in equilibrium, meaning they are fairly priced and their expected returns equal their required returns.
D) the Warren Buffets of the market have proven that stocks are not fully and fairly priced, so investors should spend time searching for mispriced (over- or under-valued) stocks.

Question 13

In the present value model, risk is generally incorporated into

A) cash flows.
B) the discount rate.
C) the total value.
D) the timing.

Question 14

A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. Theissue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar riskare currently earning 11 percent, the firm's bond will sell for __________today.

A) $1,000
B) $841
C) $1,123
D) $717

Question 15

__________is the value of the firm's ownership in the event that all assets are sold for their exact accounting value and the proceeds remaining after paying all liabilities (including preferred stock)are divided among common stockholders.

A) Book value
B) The present value of the common stock
C) The P/E multiple
D) Liquidation value

Question 16

A firm has a balance sheet common shares account with a value of $540,000. The firm has 40,000common shares outstanding. If the preferred shares account has a value of $250,000, the commonstock originally sold for

A) $12.50/share.
B) $15.50/share.
C) $19.75/share.
D) $13.50/share.

Question 17

__________is the actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.

A) Liquidation value
B) Book value
C) The present value of the dividends
D) The P/E multiple

Question 18

If the required return is less than the coupon rate, a bond will sell at

A) book value.
B) a premium.
C) par.
D) a discount.

Question 19

What is the yield to maturity, to the nearest percent, for the following bond: current price is $908, coupon rate is 11 percent, $1,000 par value, interest paid annually, eight years to maturity?

A) 15 percent
B) 11 percent
C) 9 percent
D) 13 percent

Question 20

Chicken Delight has entered 28 markets and has built a stable consumer base; the company also hasmany growth prospects if it can find competent local working-partners. Last year Chicken Delightpaid a $0.45 per share dividend. The company shares were trading at $7.20 at the beginning of the year and $7.84 at the end. Chicken Delights capital gain yield last year was

A) 15.14%
B) 8.16%
C) 8.89%
D) 6.25%

Question 21

The return expected from an asset is fully defined by its

A) risk and cash flow.
B) discount rate.
C) cash flow and timing.
D) beta.

Question 22

The process that links risk and return in order to determine the worth of an asset is termed

A) valuation.
B) evaluation.
C) discounting.
D) variable growth.

Question 23

AFK Inc.'s next dividend payment will be $4.00 per share. The dividends are anticipated to maintain a 5% growth rate forever. If AFK stock currently sells for $20 per share, what is the dividend yield?

A) 20%
B) 25%
C) 12.5%
D) 5%

Question 24

The __________ rate of interest is the actual rate charged by the supplier and paid by the demander of funds.

A) inflationary
B) risk-free
C) nominal
D) real

Question 25

The_________ is the annual rate of interest earned on a security purchased on a given date and held to maturity.

A) yield curve
B) term structure
C) risk-free rate
D) yield to maturity

Question 26

Economically rational buyers and sellers use their assessment of an asset's risk and return todetermine its value. Relative to this concept, which of the following is true:

A) The interaction of buyers and sellers can result in a value that differs from the stock's true value.
B) To a buyer the asset's value represents the minimum price that he or she would pay to acquire it.
C) To a buyer the asset's value represents the maximum price that he or she would pay to acquire it.
D) To a seller the asset's value represents the maximum sale price.

Question 27

Common stocks are difficult to value for all the following reasons EXCEPT

A) cash flows are not known.
B) the rate of return required by the market is difficult to establish.
C) the Board of Directors changes periodically.
D) the life of the investment is essentially forever.

Question 28

For bonds with the same time to maturity, __________bonds have the lowest yield to maturity.

A) Royal Bank
B) Government of Canada
C) Air Canada
D) Saskatchewan Wheat Pool

Question 29

The key inputs to the valuation process include

A) returns, discount rate, and risk.
B) cash flows and discount rate.
C) returns and risk.
D) returns, timing, and risk.

Question 30

Calculate the value of a $1,000 bond which has 10 years until maturity and pays quarterly interest at an annual coupon rate of 12 percent. The required return on similar-risk bonds is 20 percent.

A) $2,201
B) $657
C) $835
D) $846

Question 31

A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4. Therequired return on the preferred stock has been estimated to be 16 percent. The value of thepreferred stock is _________ .

A) $64
B) $50
C) $16
D) $25

Question 32

If the expected return is above the required return on an asset, rational investors will

A) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return.
B) sell the asset, which will drive the price down and cause the expected return to reach the level of the required return.
C) buy the asset, which will drive the price up and cause the expected return to reach the level of the required return.
D) sell the asset, since the price is expected to decrease.

Question 33

The cost of long-term debt generally _________that of short-term debt.

A) is greater than
B) has no relation to
C) is less than
D) is equal to

Question 34

If expected return is less than required return on an asset, rational investors will

A) buy the asset, which will drive the price up and cause the expected return to reach the level of the required return.
B) buy the asset, since the price is expected to increase.
C) sell the asset, which will drive the price down and cause the expected return to reach the level of the required return.
D) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return.

Question 35

The ABC company has two bonds outstanding that are the same except for the maturity date. BondD matures in 4 years, while Bond E matures in 7 years. If the required return changes by 15 percent

A) Bond E will have a greater change in price.
B) Bond D will have a greater change in price.
C) the price of the bonds will be constant.
D) the price change for the bonds will be equal.

Question 36

According to the efficient market theory,

A) prices of actively traded stocks can only be under-valued in an efficient market.
B) prices of actively traded stocks can only be over-valued in an efficient market.
C) prices of actively traded stocks do not differ from their true values in an efficient market.
D) prices of actively traded stocks can be under- or over-valued in an efficient market, and bear searching out.

Question 37

_________is a guide to the firm's value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.

A) Book value
B) The P/E multiple
C) The present value of the dividends
D) Liquidation value

Question 38

A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock and expects the dividend per share in the coming year to be $2.70. The firm can earn 12 percent on similar risk involvements. The value of the firm's common stock is _________ .

A) $30/share
B) $90/share
C) $22.50/share
D) $9/share

Question 39

If the required return is greater than the coupon rate, a bond will sell at

A) a premium.
B) book value.
C) a discount.
D) par.

Question 40

The nominal rate of interest is composed of

A) the real rate plus a risk premium.
B) the real rate plus an inflationary expectation.
C) the risk-free rate plus an inflationary expectation.
D) the risk-free rate plus a risk premium.

Question 41

The theory suggesting that for any given issuer, long-term interest rates tends to be higher thanshort-term rates is called

A) the market segmentation theory.
B) the expectation hypothesis.
C) the liquidity preference theory.
D) none of the above.

Question 42

A common stock currently has a beta of 1.3, the risk-free rate is an annual rate of 6 percent, and the market return is an annual rate of 12 percent. The stock is expected to generate per-share benefitsof $5.20 during the coming period. A toxic spill results in a lawsuit and potential fines, and the beta of the stock jumps to 1.6. The new equilibrium price of the stock_________ .

A) will be $33.33
B) will be $37.68
C) will be $43.33
D) cannot be determined from the information given

Question 43

Corporate bonds typically have

A) a market price of $1000.
B) a par value of $1000.
C) a specified coupon rate paid annually.
D) a face value of $5000.

Question 44

Assume you bought a $1,000, 8% annual coupon bond one year ago for $750, and sold it today for $810. What was your holding period yield?

A) 8.00%
B) 18.67%
C) 2.47%
D) 17.28%

Question 45

Mugwump Industries has issued a bond which has a $1,000 par value and a 15 percent annual coupon interest rate. The bond will mature in ten years and currently sells for $1,250. Using the approximation formula to calculate the yield to maturity (YTM) of this bond results in a YTM of

A) 15.00 percent.
B) 42.22 percent.
C) 11.11 percent.
D) 27.78 percent.

Question 46

When the required return is constant but different from the coupon rate, the price of a bond as itapproaches its maturity date will

A) remain constant.
B) decrease.
C) increase.
D) approach par.

Question 47

The market price of outstanding issues often varies from par because

A) the maturity date has changed.
B) old bonds sell for less than new bonds.
C) the market rate of interest has changed.
D) the coupon rate has changed.

Question 48

For an investor who plans to purchase a bond maturing in one year, the primary consideration should be

A) the interest rate risk.
B) the coupon rate.
C) the yield to maturity.
D) the changes in the risk of the issue.

Question 49

The risk premium consists of a number of components, including all of the following EXCEPT

A) liquidity risk.
B) tax treatment risk.
C) inflationary risk.
D) default risk.

Question 50

When valuing a bond, the characteristics of the bond that remain fixed are all of the followingEXCEPT the

A) interest payment.
B) price.
C) face value.
D) coupon rate.

Question 51

A firm has an issue of $1000 par value bonds with a 12 percent stated interest rate outstanding. The issue pays interest annually and has 10 years remaining to its maturity date. If bonds of similar risk are currently earning 8 percent, the firm's bond will sell for_________ today.

A) $805
B) $1,268
C) $1,000
D) $851

Question 52

What is the current price of a $1000 par value bond maturing in 12 years with a coupon rate of 14percent, paid semiannually, that has a YTM of 13 percent?

A) $1073
B) $1060
C) $1090
D) $604

Question 53

Al is trying to decide which of two bonds to buy. Bond H is a 10 percent coupon, 10-year maturity,$1,000 par, January 1, 2000 issue paying annual interest. Bond F is a 10 percent coupon, 10-yearmaturity, $1,000 par, January 1, 2000 issue paying semiannual interest. The market required returnfor each bond is 10 percent. When using present value to determine the prices of the bonds, Al will find that

A) the price of H is greater than F.
B) the price of F is greater than H.
C) there is no difference in price.
D) he needs more information before determining the prices.

Question 54

The yield curve in an economic period of low to moderate inflation would most likely be

A) upward-sloping.
B) linear.
C) flat.
D) downward-sloping.

Question 55

Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of dividends of 10 percent, and a required return of 20 percent. The value of a share of Emmy Lou, Inc.'s common stock is__________.

A) $56.00
B) $28.00
C) $18.67
D) $22.40

Question 56

An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs is called

A) an inverted yield curve.
B) a flat yield curve.
C) a normal yield curve.
D) none of the above.

Question 57

When the required return is constant and equal to the coupon rate, the price of a bond as itapproaches its maturity date will

A) remain constant.
B) decrease.
C) change depending on whether it is a discount or premium bond.
D) increase.

Question 58

If a bond pays $1,000 plus interest at maturity, $1,000 is called the

A) stated value.
B) par value.
C) long-term value.
D) market value.

Question 59

The theory that explains only the tendency for the yield curve to be upward sloping is

A) the investor perception theory.
B) the expectations hypothesis.
C) the market segmentation theory.
D) the liquidity preference theory.

Question 60

_________of all future cash flows an asset is expected to provide over a relevant time period is the value of the asset.

A) The stated value
B) The future value
C) The present value
D) The sum

Question 61

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?

A) 8.5 percent
B) 12.0 percent
C) 13.2 percent
D) 9.4 percent

Question 62

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

A) $8.80
B) $4.00
C) $8.00
D) $80.00

Question 63

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 _________.

A) $120
B) $100
C) $12
D) $10

Question 64

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.

A) equal to the par value; at a premium; at a discount
B) at a premium; equal to the par value; at a discount
C) at a premium; at a discount; equal to the par value
D) at a discount; at a premium; equal to the par value

Question 65

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?

A) the business is correctly priced; you get what you pay for
B) the business is overpriced; walk away
C) cannot be answered with the information provided
D) the business is underpriced; buy

Question 66

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

A) greater demand for long-term rather than short-term loans relative to the supply of such loans.
B) lender preferences for shorter term, more liquid loans.
C) the general expectation of higher future rates of inflation.
D) all of the above.

Question 67

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

A) present value of a nongrowing dividend stream.
B) present value of a constant, growing dividend stream.
C) net value of all assets which are liquidated for their exact accounting value.
D) actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.

Question 68

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

A) inflationary
B) nominal
C) risk-free
D) real

Question 69

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 __________.

A) premium; a discount; par
B) par; a discount; a premium
C) coupon; a premium; a discount
D) discount; par; a premium

Question 70

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

A) greater
B) there is no relationship between interest rate risk and time to maturity
C) lower
D) more stable

Question 71

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

A) normal yield curve.
B) flat yield curve.
C) inverted yield curve.
D) none of the above.

Question 72

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

A) the comparative equilibrium of supply and demand in the short-term and long-term market segments.
B) inflationary expectations.
C) liquidity preferences.
D) all of the above.

Question 73

The value of a bond is the present value of the

A) interest and dividend payments.
B) maturity value.
C) dividends and maturity value.
D) interest payments and maturity value.

Question 74

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

A) an unchanged
B) a higher
C) a lower
D) an undetermined

Question 75

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

A) a company on the verge of failure
B) an respected growth company
C) a mature company
D) a relatively new company

Question 76

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?

A) $26.50
B) $13.50
C) $15.00
D) $30.00

Question 77

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?

A) $16.67
B) $12.50
C) $25.00
D) $26.00

Question 78

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

A) 14.79%.
B) 13.20%.
C) 10.45%.
D) 11.97%.

Question 79

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

A) the security markets theory.
B) the market segmentation theory.
C) the liquidity preference theory.
D) the expectations hypothesis.

Question 80

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

A) debt represents ownership interest in a firm while equity does not
B) Interest payments on equity are tax deductible for the issuer while those on debt are not
C) debt requires interest payments while equity does not
D) equity carries with it the possibility of financial distress while debt does not