The valuation of a financial asset is based on determining:
a. the present value of future cash flows
b. the current yield to maturity on long term corporate bonds
c. the capital budgeting process
d. what the corporation is paying to attract preferred shareholders
a. the present value of future cash flows
The market required rate of return depends on:
a. the present value of future cash flows
b. the market's perceived level of risk associated with the individual security
c. the yield to maturity
d. the valuation of the financial asset
b. the market's perceived level of risk associated with the individual security
The interest rate used to discount the cash flows associated with a bond is:
a. the required rate of return on the firm's equity
b. the yield to maturity
c. the prime rate
d. the government T-bill rate
b. the yield to maturity
When the coupon rate on a bond is equal to the yield to maturity, the price of the bond will be:
a. par
b. above par
c. below par
d. more information is required
a. par
All of the following factors influence the investor's required rate of return except:
a. the real required rate of return
b. the inflation premium
c. the risk premium
d. the risk aversion factor
d. the risk aversion factor
Business risk relates to:
a. the ability of the firm to hold its competitive position
b. the ability of the firm to maintain growth in its earnings
c. the ability of the firm to maintain stability in the earnings
d. all of the above are correct
d. all of the above are correct
Financial risk relates to:
a. the ability of the firm to pay dividends
b. the ability of the firm to access capital markets for additional funds
c. the ability of the firm to meet debt obligations as they come due
d. the firm's financial risk premium
c. the ability of the firm to meet debt obligations as they come due
If there is an increase in the inflation premium:
a. the yield to maturity will decrease
b. the price of the bond will decrease
c. the maturity of the bond will change proportionally
d. there will be no effect on the price of the bond
b. the price of the bond will decrease
If the yield to maturity changes, the effect will be greatest on:
a. long term bonds
b. short term bonds
c. government bonds
d. the effect will be the same for all bonds
a. long term bonds
The yield to maturity on a bond:
a. is determined by government regulations
b. equates principal and interest payments to the price of the bond
c. is constant with varying maturities
d. tends to move inversely with share prices
b. equates principal and interest payments to the price of the bond
In the "real world," corporate bonds usually pay interest:
a. continuously
b. quarterly
c. semiannually
d. annually
c. semiannually
To determine the price of preferred stock:
a. divide the rate of return by the dividend amount
b. divide the dividend amount by the rate of return
c. divide the dividend amount by the rate of return minus the growth rate
d. divide the dividend amount by the growth rate
b. divide the dividend amount by the rate of return
The value of a share of common stock may be thought of as:
a. a perpetuity
b. an annuity
c. the present value of a perpetuity
d. the present value of expected future dividends
d. the present value of expected future dividends
The price-earnings ratio is affected by:
a. the earnings and sales growth of the firm
b. the volatility of the firm's performance
c. the debt-equity structure of the firm
d. all of the above are correct
d. all of the above are correct
The required rate of return on an equity investment can be determined by:
a. the P/E yield plus the growth rate
b. the dividend yield plus the growth rate
c. the earnings yield
d. the revenue growth rate
b. the dividend yield plus the growth rate
business risk:
The risk related to the inability of the firm to hold its competitive position and maintain stability and growth in earnings.
discount rate:
The interest rate at which future sums or annuities are discounted back to the present.
dividend valuation model:
A model for determining the value of a share of stock by taking the present value of an expected stream of future dividends.
dividend yield:
Dividends per share divided by market price per share. Dividend yield indicates the percentage return that a shareholder will receive on dividends alone.
financial risk:
The risk related to the inability of the firm to meet its debt obligations as they come due.
inflation premium:
A premium to compensate the investor for the eroding effect of inflation on the value of the dollar. In the 1980s the inflation premium was 3 to 4 percent. In the late 1970s it was in excess of 10 percent.
perpetuity:
An investment without a maturity date.
price-earnings ratio:
The multiplier applied to earnings per share to determine current value. The P/E ratio is influenced by the earnings and sales growth of the firm, the risk or volatility of its performance, the debt-equity structure, and other factors.
real rate of return:
The rate of return an investor demands for giving up the current use of his or her funds on a noninflation-adjusted basis. It is payment for forgoing current consumption. Historically, the real rate of return demanded by investors has been of the magnitude of 2 to 3 percent. However, throughout the 1980s the real rate of return was higher; that is, 5 to 7 percent.
required rate of return:
That rate of return investors demand from an investment (securities) to compensate them for the amount of risk involved.
risk premium:
A premium associated with the special risks of an investment. Of primary interest are two types of risk, business risk and financial risk. Business risk relates to the inability of the firm to maintain its competitive position and sustain stability and growth in earnings. Financial risk relates to the inability of the firm to meet its debt obligations as they come due. The risk premium also differs (is greater or less) for different types of investments (bonds, stocks, and the like).
risk-free rate of return:
Rate of return on an asset that carries no risk. Treasury bills are often used to represent this measure, although longer-term government securities have also proved appropriate in some studies.
supernormal growth:
A rate of corporate growth that cannot be maintained indefinitely.
yield to maturity:
The required rate of return on a bond issue. It is the discount rate used in present-valuing future interest payments and the principal payment at maturity. The term is used interchangeably with market rate of interest.
