Finance Chapter 10
Calculate the present value of the bonds principal payment for a $5,000, 10 year bond with a stated rate of 10%, compounded annually, and a yield of 12%? Round to the nearest whole dollar.
$1,610 Reason: Using the formula in the book, the table factor at a discount/market rate of 12% =.321973236. Multiply $5,000 principal payment by the table factor of.321973236 = 1,609.87. Round up to 1,610.00. Using a Financial Calculator: FV = $5,000 I/Y = 12% N = 10 PMT = 0 CPT PV = $1,609.87 = $1,610 rounded
Preferred stock is a hybrid security because it
Does not have the legally enforceable provisions of debt; does not have the ownership privilege of common stock
Which of the following formulas is used to determine the price of preferred stock?
Dp/Kp
Which of the following formulas is used to determine the required rate of return for preferred stock?
Dp/Pp
Stockholders may be influenced by changes in earnings and other factors, but the ultimate value rests with the distribution of
Earning
The two components of the dividend growth model are the dividend yield and growth rate (capital gains yield). How is the dividend yield calculated in this model?
Expected cash dividend divided by the current price.
Types of risk(s) associated with the risk premium include ______?
financial risk, business risk
What needs to be known to determine the current value of a financial asset.
future cash flows, discount rate
The capital gains yield can be interpreted as the______ rate in a dividend growth model because we know that the dividend growth rate is the rate at which the share price grows also.
growth
If the required rate of return decreases as a result of deflation or decreased risk, the value of common stock will Blank______.
increase
An addition to the real rate of return required by investors to compensate for the effect of inflations is known as ______?
inflation premium
The required rate of return is also known as the______ rate?
Discount
The price at which a bond sells for is equal to the present value of the
interest payments, principal
real rate of return
the amount required by the investor for the use of funds on a noninflation-adjusted basis
The longer the life of a financial asset
the greater the impact of a change in the required rate of return.
To determine the price of a bond, the interest payments and the principal must be discounted by the ______
yield to maturity
What is the present value of interest payments for $5,000, 10 year bond with a stated coupon rate of 12% and a market rate of 10%? (Round to the nearest whole dollar)
$3,687
What is the present value of interest payments for $1,000, 5 year bond with a stated coupon rate of 8% and a market rate of 10%?
$303 Explanation: Reason: To determine the annuity (interest payments) multiply $1,000 by 8% stated rate = $80. Go to the PV of an annuity of $1 table and find the table factor associated with 5 periods at a 10% discount/market rate = 3.791. Multiply $80 interest payment by the table factor of 3.791 = 303.28 Using Financial Calculator
If a company's P/E ratio is 12 and earnings per share of stock are $4, what is the market price of the stock?
$48
Calculate the present value of $5,000, 10 year bonds with a stated rate of 12% and a market rate of 10%? Round to the nearest whole dollar.
$5,614 Reason: Reason:To determine the annuity (interest payments) multiply $5,000 by 12% stated rate = $600. Using the formula in the book, the table factor at a discount/market rate of 10% = 6.144567106. Multiply $600 interest payment by the table factor of 6.144567106 = 3,686.74. The present value of the principal payment of $5,000/(1+10%)10 = $1,927.72. Present value of bond = $3,686.74 + $1,927.72 = $5,614.46, or $5,614.Using calculator: n = 10, PMT = $600, r = 10%, FV = $5,000, PV = $5,614.46, or $5,614
Which factor(s) would cause the bond to sell above par value (for a premium)?
Decreased business risk, Decreased inflation
What is the present value of principal payment for $1,000, 5 year bond with a stated coupon rate of 8% and a market rate of 10%?
$621 Reason: To determine the single principal payment at maturity go to the PV of $1 table and find the table factor associated with 5 periods at a 10% discount/market rate =.621. Multiply $1,000 principal payment by the table factor of.621 = 621.00 Using a Financial Calculator: FV = $1,000 I/Y = 10% PMT = 0 N = 5 CPT PV = $620.92 = $621 rounded
Calculate the present value of the bond's interest payments. The interest payments are $200 annually for 6 years at a discount rate of 6%. Use the formula method to calculate the present value.
$983.46
If the stated interest rate on the bond is 10%, what is the yield to maturity (discount rate) that will cause the bond to trade at par value?
10%
Common stock has a dividend of $2.00 at the end of the first year, a growth rate of 6%, and a required rate of return of 8%. What is the price of the common stock?
100
Given the following information, what is the required rate of return for this investment. Real rate of return 4% Inflation premium 3% Risk premiums 5%
12%
Historically, the real rate of return demanded by investors has been about ___?
2 to 3 percent
Given the following information, what is the risk-free rate of return for this investment. Real rate of return 4% Inflation premium 3% Risk premiums 5%
7%
the real rate of return is 5% and the inflation premium is 3%, what is the risk-free rate of return?
8%
The present value of the principal payment for a $10,000, 10 year bond with a coupon rate of 8% paid semiannually with a market rate of 10% is $.
8,753.78 or 8753.78
M&M International paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 5% over the next three years. The required rate of return is 10%. What is the price of the stock at the end of first year?
84.00
What is the reward to financial managers who use capital efficiently?
A lower required return
Assume a bond's stated rate is 8% and the yield to maturity is 6%, will the bonds sell for par value, above par value, or below par value?
Above par value
A bond provides an _____ _____ which is a stream of interest payments of equal amount for a period of time.
Annuity Stream
If the rate of return required of a financial asset increases, the value of the financial asset will
Decrease
What is the present value of interest payments for a $10,000, 10 year bond that pays an 8% coupon rate semiannually if the market rate of 10%?
Approximately $4,900 Reason: To determine the annuity (interest payments) multiply $10,000 by 4% coupon rate = $400. Go to the PV of an annuity of $1 table and find the table factor associated with 20 periods at a 5% discount/market rate = 12.462. Multiply $400 interest payment by the table factor of 12.462 = 4984.80
What is the present value of $1,000, 5 year bond with a stated coupon rate of 8% and a market rate of 10%?
Approximately $900 Reason: To determine the annuity (interest payments) multiply $1,000 by 8% stated rate = $80. Go to the PV of an annuity of $1 table and find the table factor associated with 5 periods at a 10% discount/market rate = 3.791. Multiply $80 interest payment by the table factor of 3.791 = 303.28. Add this amount to the present value of the principal payment
Assume a bond's stated rate is 5% and the yield to maturity is 6%, will the bonds sell for par value, above par value, or below par value?
Below par value
If preferred stock had a maturity date, it would be valued in the same manner as ______.
Bonds
The inability of a firm to hold its competitive position and maintain stability and growth in earnings is known as ______.
Business Risk
The value of stocks and bonds is based on the present value of the future
Cash Flows
There is a strong ______ between the risk the investor takes and the return the investor demands.
Correlation
Which of the following formulas is used to determine the price of common stock? Assume that there is no growth in dividends.
D1/Ke
Which of the following formulas is used to determine the price of common stock with constant growth in dividends?
D1/Ke-g
The present value of the interest payments and principal payment should be discounted at the coupon rate.
False
True or false: The current price of stock is the future value of the present stream of dividends growing at a constant rate.
False
the amount required by the investor for the use of funds on a noninflation-adjusted basis
False
The inability of a firm to meet debt obligations as they come due is known as ______.
Financial Risk
A $1,000,000, 20 year bond has a stated rate of 10% and sells for $928,000. What is the yield to maturity?
Greater than 10%
Which factor(s) would cause the bond to sell below par value (for a discount)?
Increased inflation, Increased business risk
A $500,000, 10 year bond has a stated rate of 8% and sells for $520,000. What is the yield to maturity?
Less than 8%
If the required rate of return increases as a result of inflation or increased risk, the growth rate of common stock will Blank______.
Not change
If the interest rate stated on the bond is equal to the yield to maturity (discount rate), the bonds will sell for
Par value
Which of the following is a hybrid security?
Preferred Stock
The valuation of a financial asset is based on determining the ______ value of future cash flows.
Present
The price of a bond is based on which cash flow(s)?
Principal payment at maturity, Interest payments
What factors influence the bondholder's or investor's required rate of return?
Real rate of return, Risk premium, Inflation premium
The real rate of return is the financial ______ the investor charges for using his or her funds for a given period of time.
Rent
The ______ rate of return depends on the market's perceived level of risk associated with a security.
Required
Y, in the bond market, represents the required rate of return for bonds of a given______ and maturity.
Risk
The rate of return that compensates the investor for current use of funds and the loss in purchasing power.
Risk-free rate of return
The ______ has the shortest time to maturity among government bonds.
Treasury Bill
Risk premiums on common stock are generally higher than bonds due to bonds' contractually required interest payments to the investors.
True
The graph of the relationship between time to maturity and yield to maturity, for bonds that differ only in their maturity dates is known as the ______.
Yield Curve
Cash flows are discounted at Y. What does Y represent?
Yield to maturity
The size of the inflation premium required by an investor is
based on expectations of future inflation
risk-free rate of return
combines the real rate of return and the inflation premium
Valuation concepts can be applied to
common stock, preferred stock, bonds
Factors that influence the price-earnings ratio include
dividend policy, quality of management, earnings
Preferred stock is referred to as a ____because it has no maturity date.
perpetuity
The value of a share of common stock may be interpreted as the
present value of an expected stream of future dividends
The rate of return the investor demands for giving up the current use of funds on a noninflation-adjusted basis is called ______?
real rate of return
A premium associated with special risks associated with a given investment is known as ______.
risk premium
The market allocates capital to companies based on
risk, efficiency, expected returns
The price of a bond can be determined using a formula. Choose the term(s) from the list below that are involved in pricing a bond.
take the sum of the present values of the interest payments, take the present value of the principal payment at maturity
inflation premium
the amount required by the investor for the use of funds adjusted for the erosion of the value of the dollar
The rate of return required by bondholders is called ______?
yield to maturity, discount rate