Unit 20
The difference between present value and net present value represents A) the initial cash outlay B) the internal rate of return C) the discounted cash flow D) the credit risk premium
A) the initial cash outlay NPV - PV = CMV or CF (cost of investment, initial cash out lay)
Which of the following attributes of common stock best describes why internal rate of return (IRR) is not generally used to determine the return on common stock? A) No net present value B) Uneven cash flows, no maturity date and price C) Uneven cash flows D) Uneven cash flows and no maturity
B) Uneven cash flows, no maturity date and price
If the required rate of return is less than anticipated in a present value calculation, the effect would be that the A) present value would be higher. B) yield to maturity (YTM) would decrease. C) future value would be lower. D) present value would be lower.
A) present value would be higher. The present value computation is used to determine how much money must be deposited now (present) to reach a specified future goal when you know how many years you have to reach that goal. One critical component of the formula is the rate of return used in the formula. As a simple example, if you need $100,000 18 years from now for your newborn's college education and you expect to earn 8%, you'll have to deposit approximately $25,000 now (present value) to reach the goal. However, if it turns out that the earnings rate is less than anticipated, say only 4%, then you would have to deposit twice as much presently. Therefore, we answer this question by indicating that a lower rate of return will require a higher present value.
A client is meeting with you to discuss the best way to invest today to meet the goal of funding their child's college expenses. The least important information needed to determine the amount to deposit is A) current college costs B) age of the child C) parent's salary D) expected inflation rate
C) parent's salary The client is basically asking, "How much do I have to deposit now to have enough for college in x years?" The number of years depends on the age of the child. The future cost depends on today's cost plus expected inflation. Those numbers are entered into the present value calculation and result in the amount that must be deposited today to reach the future goal. When looking for a lump sum, salary is not relevant.
Portfolio A has a beta of 1.0 and has returned 8% over the past year. Portfolio B has a beta of 1.5 and, over that same period, has returned 16%. Based on this information, an analyst would conclude that portfolio B has A) positive correlation. B) negative alpha. C) positive alpha. D) zero alpha.
C) positive alpha. Positive alpha is when a portfolio (or security) outperforms another portfolio (or the market) by more than is expected based upon its beta coefficient. Although we could calculate the alpha, it should be clear that when one portfolio with a beta that is 50% higher than the other outperforms it by 100%, there is positive alpha.
In terms of volatility, low std dev is....
the least volatile
NPV is
the difference between initial cash outflow (investment) and the present value of discounted cash flows NPV = PV - CMV or CF (cost of investment)
An analyst wishes to assess the value of a fixed income security by taking the income payments scheduled to be received over a given future period and adjusting that for the time value of money. This analytical tool is known as
discounted cash flow
In terms of volatility, high std dev is....
the most volatile
