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Chapter 10 Test Bank – Static Key
1. The valuation of a financial asset is based on the concept of determining the present value of future cash
flows that this financial asset will accumulate.
2. The prices of financial assets are based on the expected value of future cash flows, the discount rate,
and past dividends.
3. The market-determined required rate of return is the appropriate discount rate used in valuation
calculations.
4. The discount rate depends on the market’s perceived level of risk associated with an individual security.
5. By using different discount rates, the market allocates capital to companies based on their risk,
efficiency, and expected returns.
6. In estimating the market value of a bond, the coupon rate should be used as the discount rate.
7. Most bonds promise both a periodic return and a lump-sum payment.
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8. A 10-year bond pays 6% annual interest in semi-annual payments. The current market yield to maturity
is 4%. The appropriate interest factors used to calculate the sales price of this bond should be in the TVM
tables under 2% for 20 periods.
9. The price of a bond is equal to the present value of all future interest payments added to the present
value of the principal.
10. The coupon rate is used to calculate the bond’s interest amount, while the yield is used to calculate the
present value of both the interest amount and principal amount of the bond.
11. When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value or
equal to its principal amount.
12. An increase in the yield of a bond compared to the coupon rate would be associated with an increase in
the price of a bond.
13. You hold a long-term bond yielding 10%. If interest rates fall before you sell the bond, you will sell at a
higher price than if interest rates had been constant.
14. When a bond trades at a discount to par, the yield to maturity on the bond will exceed the required
return.
15. The yield to maturity is always equal to the interest payment of a bond.
16. The appropriate discount rate for valuation of bonds is called the yield to maturity.
17. The coupon rate or required return of bonds is equal to the stated rate on the bond’s contract.
18. The total required real rate of return is equal to the real rate of return plus the inflation premium.
19. Historically, the real rate of return has been about 2% to 3%.
20. The required rate of return is the payment demanded by the investors for foregoing their ability to use
the funds themselves.
21. The inflation premium is based on past and current inflation levels.
22. The “risk-free rate of return” is equal to the inflation premium plus the real rate of return.
23. The risk premium is equal to the required yield to maturity (or rate of return) minus both the real rate of
return and the inflation premium.
24. The “risk premium” is primarily concerned with business risk, financial risk, and inflation risk.
25. “Business risk” relates to the inability of the firm to meet its debt obligations as they come due.
26. Risk premiums are higher for riskier securities, but the risk premium cannot be higher than the required
rate of return.
27. High-risk corporate bonds can be as risky as junk bonds.
28. There is a negative correlation between risk and the return investors demand.
29. When inflation rises, bond sales prices fall.
30. An increase in inflation will cause a bond’s required return to rise.
31. The higher the yield to maturity on a bond, the closer to par the bond will trade.
32. The closer the yield to maturity on a bond to the stated rate, the closer to par the bond will trade.
33. The longer the maturity of a bond, the greater the impact on price to changes in market interest rates.
34. As time to maturity increases, bond price sensitivity decreases.
35. 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.
36. The price of preferred stock is determined by dividing the fixed dividend payment by the required rate of
return.
37. Preferred stock may not having the same ownership privileges as common stock, but preferred stock is
offered a fixed dividend stream supported by a binding contractual obligation.
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38. Preferred stock would be valued the same as a common stock with a zero dividend growth rate.
39. When inflation rises, preferred stock prices fall.
40. The variable growth model is most useful for firms in emerging industries.
41. The value of a share of stock is the present value of the expected stream of future dividends.
42. Valuation of a common stock with no dividend growth potential is treated in the same manner as
preferred stock.
43. The constant dividend growth valuation formula is P0 = D1/(Ke – g)
44. The variable growth dividend model can be used for both constant and variable growth stocks.
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45. To use a dividend valuation model, a firm must have a constant growth rate, and the discount rate must
not exceed the growth rate.
46. The drawback of the future stock value procedure is that it does not consider dividend income.
47. Future stock value is equal to P0 = D1/(Ke – g)assuming a constant growth in dividends.
48. Firms with an expectation for great potential tend to trade at low P/E ratios.
49. The price-earnings ratio is another tool used to measure the value of common stock.
50. Firms with high expectations for the future tend to trade at high P/E ratios.
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51. A stock that has a high required rate of return because of its risky nature will usually have a high P/E
ratio.
52. The fact that small businesses are usually illiquid does not affect their valuation process.
53. Even though the IRS tries to minimize occurrences, small business owners often intermingle business
and personal expenses in order to minimize taxable income.
54. Valuation of financial assets requires knowledge of
55. The market allocates capital to companies based on
56. In a general sense, the value of any asset is the
57. Which of the following financial assets is likely to have the highest required rate of return based on risk?
58. A bond that has a “yield to maturity” greater than its coupon interest rate will sell for a price
59. Which of the following is not one of the components included in the required rate of return on a bond?
60. A 20-year bond pays 6% annually on a face value of $1,000. If similar bonds are currently yielding 4%,
what is the market value of the bond?
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61. A 10-year bond, with a par value equaling $1,000, pays 7% annually. If similar bonds are currently
yielding 6% annually, what is the market value of the bond? Use semi-annual analysis.
62. A 10-year zero-coupon bond that yields 6% is issued with a $1,000 par value. What is the issuance
price of the bond?
63. A 5-year zero-coupon bond was issued with a $1,000 par value to yield 8%. What is the approximate
market value of the bond?
64. Which of the following does NOT influence the yield to maturity for a security?
65. An increase in the riskiness of a particular security would NOT affect
66. If the inflation premium for a bond goes up, the sales price of the bond
67. If the yield to maturity on a bond is greater than the coupon rate, you can assume