Question 1

You have a choice between receiving $500 now and $530 in six months' time.Current interest rates are 10% p.a.(simple interest).As a rational investor,which option would you choose and why?

Accepted Answer

A) $500 now,because receiving $530 in six months' time is equivalent to earning only 6% interest,whereas in the bank you can earn 10% interest. 
B) $530 in six months' time,because $500 invested for six months is only worth $525. 
C) $500 now,because it would be worth $550 in six months' time. 
D) $500 now,because you have the option to invest or consume goods.

Question 2

Company A and Company B have identical expected earnings potential but Company B has a higher price-earnings ratio.This discrepancy:

Accepted Answer

A) can be explained by the difference in share price. 
B) can be explained by the fact that Company A pays more dividends. 
C) can be explained by the fact that Company A is considered to be riskier than Company 
D) cannot be explained.

Question 3

In general,a downward-sloping term structure implies that investors expect future short-term interest rates to:

Accepted Answer

A) decrease. 
B) increase. 
C) be the same as the current rate. 
D) none of the options given.

Question 4

The promised yield on a non-interest-bearing security with one year to maturity,a face value of $100,a 20% chance of default and an expected market rate of return of 10%,is:

Accepted Answer

A) 7.8%. 
B) 37.5%. 
C) 25%. 
D) 10%.

Question 5

As debtholders rank ahead of shareholders it is expected that the required rate of return on debt will be less than the required rate of return on shares.

Accepted Answer

A) True 
 B)False

Question 6

The difference between the opportunity cost of capital for a risky security and a risk-free security is referred to as the:

Accepted Answer

A) required rate of return. 
B) term structure. 
C) liquidity premium. 
D) risk premium.

Question 7

Interest rate risk refers to:

Accepted Answer

A) the risk-free rate of interest. 
B) the risk premium demanded on a bond in case of default. 
C) the random behaviour of past bond prices. 
D) the unforeseen losses to an investor if interest rates change.

Question 8

According to the expectations theory of the term structure of interest,if the 1-year bond rate today is 6% p.a.and the 3-year bond rate today is 7.5% p.a. ,what is the 2-year bond rate next year?

Accepted Answer

A) 7.25% 
B) 7.75% 
C) 8.25% 
D) 8.75%

Question 9

Given that dividends on a share are expected to remain indefinitely at $0.50 p.a.and that the required rate of return for the level of risk on such a share is 10% and the interest rate is 6%,the correct price for this share is:

Accepted Answer

A) $8.33. 
B) $5. 
C) $3. 
D) none of the options given.

Question 10

What is the market value of a bond that has a required rate of return of 10% p.a.and pays $50 p.a.with only two years remaining to maturity,if the redemption value is $1000 and the initial market value of the bond was $850 when it was first issued eight years ago?

Accepted Answer

A) $571.80 
B) $1421.80 
C) $826.45 
D) $913.22

Question 11

At what interest rate would investing $1000 in a bank leave you as well off as receiving $1078 in 12 months' time?

Accepted Answer

A) 5% 
B) 78% 
C) 10% 
D) 7.8%

Question 12

How much would you be prepared to pay for a share in two years' time that pays a 15c dividend each year and is currently priced at $2? Assume the required rate of return is 7.5% p.a.

Accepted Answer

A) $1.87 
B) $2.30 
C) $1.70 
D) $2

Question 13

Downward-sloping yield curves are inconsistent with the liquidity premium theory.

Accepted Answer

A) True 
 B)False

Question 14

Assume the latest dividend per share,paid recently,for ACD Ltd is 90 cents and that the required rate of return on these shares is 15% p.a.If the current share price is $19.80,the expected growth rate on these shares is:

Accepted Answer

A) 0%. 
B) 10%. 
C) 5%. 
D) 7.5%.

Question 15

Two common methods of share valuation are dividend growth models and the _________________ ratio.

Accepted Answer

The answer of Two common methods of share valuation are...

Question 16

The yield to maturity on a 1-year bond purchased for $980 with a maturity value of $1100 is:

Accepted Answer

A) 10.05% 
B) 12.24% 
C) 13.50% 
D) 14.23%

Question 17

The ________________ of interest rates is the relationship between the interest rates and time to maturity.

Accepted Answer

The answer of The ________________ of interest rates is the...

Question 18

A decision to buy an asset implies a simultaneous decision to forego:

Accepted Answer

A) future consumption. 
B) less consumption. 
C) current consumption. 
D) none of the given options.

Question 19

You have just purchased a government bond for $1100 that promises to pay $100 p.a.over the next five years.The market price of the bond has just increased to $1200.A likely reason for this is:

Accepted Answer

A) the face value of the bond has been increased. 
B) the bond is perceived by the market to be more risky now than before. 
C) interest rates,in general,have increased. 
D) interest rates,in general,have decreased.

Question 20

Given that dividends on a share are expected to remain indefinitely at $1 p.a.and that the required rate of return for the level of risk on such a share is 15%,the correct price for this share:

Accepted Answer

A) cannot be ascertained from this information. 
B) cannot be ascertained without regard to the management structure of the firm. 
C) is $1. 
D) is $6.67.

Exam 4: Applying the Time Value of Money to Security Valuation

You have a choice between receiving $500 now and $530 in six months' time.Current interest rates are 10% p.a.(simple interest) .As a rational investor,which option would you choose and why?