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Chapter 10 - Valuation and Rates of Return
1. The valuation of a financial asset is based on the concept of determining the present value
of future cash flows.
Chapter 10 - Valuation and Rates of Return
2. The prices of financial assets are based on the expected value of future cash flows, discount
rate, and past dividends.
3. The market determined required rate of return is also called the discount rate.
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.
Chapter 10 - Valuation and Rates of Return
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.
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 should be in the 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.
Chapter 10 - Valuation and Rates of Return
10. When the interest rate on a bond and its yield to maturity are equal, the bond will trade at
par value.
11. An increase in yield to maturity would be associated with an increase in the price of a
bond.
12. You hold a long-term bond yielding ten percent. If interest rates fall shortly before you
sell the bond, you will sell at a higher price than if interest rates had been constant.
13. When a bond trades at a discount to par, the yield to maturity on the bond will exceed the
required return.
Chapter 10 - Valuation and Rates of Return
14. The yield to maturity is always equal to the interest payment of a bond.
15. The appropriate discount rate for bonds is called the yield to maturity.
16. The total required real rate of return is equal to the real rate of return plus the inflation
premium.
17. Historically the real rate of return has been 2 to 3%.
18. The required rate of return is payment demanded by the investor for foregoing present
consumption.
Chapter 10 - Valuation and Rates of Return
19. The inflation premium is based on past and current inflation levels.
20. The risk-free rate of return is equal to the inflation premium plus the real rate of return.
21. The risk premium is equal to the required yield to maturity minus both the real rate of
return and the inflation premium.
22. The risk premium is primarily concerned with business risk, financial risk, and inflation
risk.
23. Business risk relates to the inability of the firm to meet its debt obligations as they come
due.
Chapter 10 - Valuation and Rates of Return
24. Risk premiums are higher for riskier securities, but the risk premium cannot be higher
than the required return.
25. High-risk corporate bonds are as risky as junk bonds.
26. There is a negative correlation between risk and the return the investors demand.
27. When inflation rises, bond prices fall.
28. An increase in inflation will cause a bond's required return to rise.
Chapter 10 - Valuation and Rates of Return
29. The higher the yield to maturity on a bond, the closer to par the bond will trade.
30. The longer the maturity of a bond, the greater the impact on price to changes in market
interest rates.
31. As time to maturity increases, bond price sensitivity decreases.
32. 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.
Chapter 10 - Valuation and Rates of Return
33. The price of preferred stock is determined by dividing the fixed dividend payment by the
required rate of return.
34. Preferred stock is compensated for not having ownership privileges by offering a fixed
dividend stream supported by a binding contractual obligation.
35. Preferred stock would be valued the same as a common stock with a zero dividend growth
rate.
36. When inflation rises, preferred stock prices fall.
Chapter 10 - Valuation and Rates of Return
37. The variable growth model is useful for firms in emerging industries.
ownership.
38. The value of a share of stock is the present value of the expected stream of future
dividends.
39. Valuation of a common stock with no dividend growth potential is treated in the same
manner as preferred stock.
40. The constant dividend growth valuation formula is
Chapter 10 - Valuation and Rates of Return
41. The variable growth dividend model can be used for both constant and variable growth
stocks.
42. To use a dividend valuation model, a firm must have a constant growth rate and the
discount rate must not exceed the growth rate.
43. The drawback of the future stock value procedure is that it does not consider dividend
income.
44. Future stock value is equal to Po= assuming constant growth in dividends.
Chapter 10 - Valuation and Rates of Return
45. Firms with an expectation for great potential tend to trade at low P/E ratios.
46. The price-earnings ratio is another tool used to measure the value of common stock.
47. Firms with bright expectations for the future, tend to trade at high P/E ratios.
48. A stock that has a high required rate of return because of its risky nature will usually have
a high P/E ratio.
49. The fact that small businesses are usually illiquid does not affect their valuation process.
Chapter 10 - Valuation and Rates of Return
50. Even though the IRS tries to minimize occurrences, small business owners often
intermingle business and personal expenses in order to minimize taxable income.
51. Valuation of financial assets requires knowledge of
52. The market allocates capital to companies based on
Chapter 10 - Valuation and Rates of Return
53. In a general sense, the value of any asset is the
54. Which of the following financial assets is likely to have the highest required rate of return
based on risk?
55. A bond which has a yield to maturity greater than its coupon interest rate will sell for a
price
Chapter 10 - Valuation and Rates of Return
56. Which of the following is not one of the components that makes up the required rate of
return on a bond?
57. A 20-year bond pays 6% on a face value of $1,000. If similar bonds are currently yielding
5%, what is the market value of the bond? Use annual analysis.
Chapter 10 - Valuation and Rates of Return
58. A ten-year bond, with par value equals $1000, pays 7% annually. If similar bonds are
currently yielding 6% annually, what is the market value of the bond? Use semi-annual
analysis.
Chapter 10 - Valuation and Rates of Return
59. A 10-year zero-coupon bond that yields 5% is issued with a $1000 par value. What is the
issuance price of the bond (round to the nearest dollar)?
60. A 15-year zero-coupon bond was issued with a $1000 par value to yield 8%. What is the
approximate market value of the bond?
Chapter 10 - Valuation and Rates of Return
61. Which of the following does not influence the yield to maturity for a security?
62. An increase in the riskiness of a particular security would NOT affect
63. If the inflation premium for a bond goes up, the price of the bond
Chapter 10 - Valuation and Rates of Return
64. If the yield to maturity on a bond is greater than the coupon rate, you can assume:
65. The risk premium is likely to be highest for
66. The return measure that an investor demands for giving up current use of funds, without
adjusting for purchasing power changes or the real rate of return, is the
Chapter 10 - Valuation and Rates of Return
67. A ten-year bond pays 7% interest on a $1000 face value annually. If it currently sells for
$1,195, what is its approximate yield to maturity?
68. The relationship between a bond's price and the yield to maturity
