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C HAPTER 5±V ALUATION C ONCEPTS TRUE/FALSE 1. When considering stock and bond valuation models, we implicitly assume that the marginal investor is risk averse, which means that he or she requires a higher rate of return for a given level of risk than a risk neutral individual, other things held constant. 2. A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.) 3. The constant growth model used for evaluating the price of a share of common stock can also be used to find the price of perpetual preferred stock or any other perpetuity. 4. A bond's value will increase as interest rates rise over time. 5. A bond with a $100 annual interest payment with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%. 6. Other things held constant, P/E ratios are higher for firms with high growth prospects. At the same time, P/E's are lower for riskier firms, other things held constant. These two factors, growth prospects and riskiness, may either be offsetting or reinforcing as P/E determinants. 7. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be selling at a discount; i.e., the bond's market price should be less than its face (maturity) value. 8. If the prices of investment reflect existing information and adjust very quickly when new information becomes available, then the financial markets have achieved informational efficiency. 9. The longer the maturity of a bond, the more its price will change in response to a given change in interest rates; this is called interest rate price risk. MULTIPLE CHOICE 10. Assuming g will remain constant, the dividend yield is a good measure of the required return on a common stock under which of the following circumstances? a. g = 0 b. g > 0 c. g < 0 d. Under no circumstances. e. Answers a and b are both correct. 11. If the expected rate of return on a stock exceeds the required rate, a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared.
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Chapter 5 D Valuation Concepts 99 12. If the stock market is semi-strong efficient, which of the following statements is correct? a. All stocks should have the same expected returns; however, they may have different realized returns. b. In equilibrium, stocks and bonds should have the same expected returns. c.
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