MOS 3310 Corporate Finance QUIZ 2
True / False Questions (one mark each)
1) The dividend discount model states that today’s stock price equals the present value of all expected future dividends.
Correct Answer – False
2) Sustainable growth rates can be estimated by multiplying a firm’s ROE by its dividend payout ratio.
Correct Answer – False
3) A high P/E ratio indicates high level of risk.
Correct Answer – False
4) According to the dividend discount model, a stock’s price today depends on the investor’s horizon for holding the stock.
Correct Answer – False
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5) When the market interest rate exceeds the coupon rate, bonds sell for less than face value to provide enough compensation to investors
6) Current yield overstates the return of premium bonds since investors who buy a bond at a premium face a capital loss over the life of the bond.
7) A bond’s rate of return is equal to its coupon payment divided by the price paid for the bond.
8) Zero-coupon bonds are issued at prices below face value, and the investor’s return comes from the difference between the purchase price and the payment of face value at maturity.
9) . The current yield measures the bond’s total rate of return.
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Multiple Choice Questions (one mark each)
10) Which one of the following is most apt to be correct for a CCC-rated bond, compared to a BBB-rated bond?
A. the CCC bond will have a variable-coupon rate.
B. the CCC bond will have a shorter term.
C. the CCC bond will offer a higher promised yield to maturity.
D. the CCC bond will have a higher price for the same term.
11) If a bond offers a current yield of 5% and a yield to maturity of 5.45%, then the:
A. bond is selling at a discount.
B. bond has a high default premium.
C. promised yield is not likely to materialize.
D. bond must be a Treasury Inflation-Protected Security.
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12) The discount rate that makes the present value of a bond’s payments equal to its price is termed the:
A. dividend yield.
B. yield to maturity.
C. current yield.
D. coupon rate.
13) If an investor purchases a bond when its current yield is higher than the coupon rate, then the bond’s price will be expected to:
A. decline over time, reaching par value at maturity.
B. increase over time, reaching par value at maturity.
C. be less than the face value at maturity.
D. exceed the face value at maturity.
14) A firm’s liquidation value is the amount:
A. necessary to repurchase all shares of common stock.
B. realized from selling all assets and repaying debts.
C. a purchaser would pay for the firm in bankruptcy.
D. equal to the book value of equity.
15) What happens to a firm that reinvests its earnings at a rate equal to the firm’s required return?
A. its stock price will remain constant
B. its stock price will increase by the sustainable growth rate
C. its stock price will decline unless dividend payout ratio is zero
D. its stock price will decline unless plowback rate exceeds required return
16) Security prices are said to follow a “random walk,” which means that:
A. stock selection for portfolio composition is unimportant.
B. it is impossible to know whether stocks offer higher returns than bonds.
C. investment analysts are unnecessary.
D. successive price changes are unpredictable
17) Which of the following should increase the firm’s sustainable growth rate?
A. increase the dividend payout ratio
B. decrease the required return
C. decrease the ROE
D. increase the plowback ratio
18) An investor is faced with the decision of whether to invest in a stock with an expected return of 14% or a stock in the same industry with an expected 20% return. Which of the following seems most likely?
A. the 20% stock is a better investment.
B. the 14% stock is overpriced.
C. Both stocks will have approximately the same return.
D. Both stocks are priced correctly given their perceived risk.
19) If a 4-year bond with a 7% coupon and a 10% yield to maturity is currently worth $904.90, how much will it be worth 1 year from now if interest rates are constant?
A. $904.90
B. $925.39
C. $947.93
D. $1,000.00
20) You purchased a 6% annual coupon bond at par and sold it one year later for $1,015.16. What was your rate of return on this investment if the face value at maturity was $1,000?
A. 4.48%
B. 6.15%
C. 7.52%
D. 6.07%
21) If a bond offers an investor 11% in nominal return during a year in which the rate of inflation is 4%, then the investor’s real return is:
A. 6.73%.
B. 6.31%.
C. 15.44%.
D. 10.56%
22) What proportion of earnings is being plowed back into the firm if the sustainable growth rate is 8 percent and the firm’s ROE is 20 percent?
A. 8 percent
B. 12 percent
C. 20 percent
D. 40 percent
23) What price would you expect to pay for a stock with 13 percent required rate of return, 4 percent rate of dividend growth, and an annual dividend of $2.50 which will be paid tomorrow?
A. $27.78
B. $30.28
C. $31.10
D. $31.39
24) If a stock’s P/E ratio is 13.5 at a time when earnings are $3 per year, what is the stock’s current price?
A. $4.50
B. $18.00
C. $22.22
D. $40.50
25) If the dividend yield for year one is expected to be 5 percent based on the current price of $25, what will the year four dividend be if dividends grow at a constant 6 percent?
A. $1.33
B. $1.49
C. $1.58
D. $1.67
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