Chapter 3 part II Flashcards
Using the constant growth dividend discount model, what is the intrinsic value of a stock with a $2.00 annual dividend, a 5% dividend growth rate, and a 10% required rate of return?
a. $40
b. $42
c. $44
d. $46
b. $42
V = Do (1 + g) / r - g
2.0(1+.05) /.10-.05 =
2.1 / .05 = 42
Rex owns a corporate bond that currently sells for $1,090. The coupon rate is 9%, and the bond matures in 23 years. The bond is callable in eight years at $1,020.
What is the yield to maturity of this bond?
a. 6.84%
b. 7.66%
c. 7.93%
d. 8.13%
d. 8.13%
N - 46
I/yr - ?
PV - 1090
PMT - 45
FV - 1000
i/yr - 8.129 or 8.13
The non-interest-rate factors that affect bond valuations include the following, except
a. maturity risk
b. credit risk
c. reinvestment risk
d. currency risk
a. maturity risk
is a false phrase in the context of this question.
Fundamental analysis includes which of the following?
l. computation of the current ratio
ll. comparison of a company’s PEG ratio to its industry’s PEG ratio
lll. computation of the company’s debt to equity ratio
lV. comparison of a company’s daily trading volume to its historical volume
a. l and ll
b. l and lll
c. l, ll, and lll
d. l, lll, and lv
c.
Fundamental analysis includes computation of the current ratio, comparison of a company’s PEG ratio to its industry’s PEG ratio, and computation of the company’s debt to equity ratio
List several characteristics of common stock
- shareholders receive dividends on a pro rata basis
- shareholders vote on the election of corporate board members
- shareholders are residual owners of the firm, meaning their interests are subordinate to creditors and bondholders
- shares have no maturity
List several sources of risk for common stock:
- downturn in economic growth
- high interest rates
- loss of product or service competitiveness
- failures of management
- government action
List characteristics of preferred stock:
- dividends usually fixed, usually ‘qualified,’ and are not tax deductible to the paying corporation
- preferred shares are paid dividends ahead of common shares
limited voting rights
dividends are generally 70% tax free to owning corporations, and they can have participating, cumulative, callable, and convertible features
List sources of risk for preferred stock:
- interest rate risk
- purchasing power risk
- business risk
- reinvestment risk
List the characteristics of bonds:
- issued by corporations, federal and state gov and their agencies, and municipalities
- a promise to repay the principal amount at a specified date in the future
- make periodic interest payments at a specified rate at specified dates
usually isuued at par value
total return consists of interest and any capital gain or loss - can provide taxable or tax-free income
- rated investment grade (top four grades) or non investment grade (below the top four grades)
List investment risks of bonds and other debt instruments:
- default risk
- purchasing power risk
- interest rate risk
- call risk
- reinvestment risk
- currency risk (for foreign bonds)
Explain treasury notes
T-notes have maturities over one and up to ten years, are sold at or near face value, pay interest semiannually, have a minimum denomination of $100 face value, and are sold in multiples of $100.
Explain treasury bonds
T-bonds have maturities over 10 and up to 30 years, are sold at or near face value, pay interest semiannually, have a minimum denomination of $100, and are sold in multiples of $100 face value
Explain treasury inflation-protected securities (TIPS)
These bonds offer a rate of return that increases with inflation as measured by the consumer price index (CPI). As inflation increases, the bond’s principal increases at the same percentage as the increase in the CPI
Excellent securities to offset inflation; in contrast to traditional bonds that are negatively affected by inflation.
Less liquid than other treasury securities.
Explain Treasury STRIPS
these are zero-coupon instruments sold at deep discounts to face value, with the difference being interest instead of periodic interest payments. The treasury does not issue or sell STRIPS directly to investors.
Explain the following regarding corporate bonds - Indenture
the indenture spells out the terms of the issue
Explain the following regarding corporate bonds - trustee
The trustee acts as a fiduciary on behalf of bondholders to ensure that the indenture provisions are met.
Explain the following regarding corporate bonds - interest taxation
interest is fully taxed at both the federal and state levels
Explain the following regarding corporate bonds - mortgage bonds
bonds are secured by property, usually real estate
Explain the following regarding corporate bonds - debentures
These are unsecured bonds
Explain the following regarding corporate bonds - equipment trust certificates
bonds are secured by specific equipment, usually airplanes or railroad cars.
Explain the following regarding corporate bonds - convertible bonds
these bonds can be converted into the underlying stock at the option of the bondholder.
List characteristics of mortgage backed securities
- major issuers are GNMA, FHLMC, and FNMA
- make monthly payments
- payments represent interest and principal; total payments can change over time (due to refinancing)
List sources of risk for mortgage-backed securities
- uncertainty of cash flows
- interest rate risk
- purchasing power risk
- reinvestment risk
- FHLMC and FNMA have a slight potential for default risk (since they aren’t backed by the US gov).
List forms of real estate investments
- home ownership
- raw land
- commercial property
- apartment buildings
- RELPs
- REITs
Risk of real estate investments
Prices of real estate can fall, especially after periods of high price increases and when loans are easy to get. Real estate is also subject to low liquidity, high transaction costs, and complex tax reporting requirements.
Major characteristics of mutual funds
- open-end investment company that pools the money of many investors.
- large number of individual securities in a funds portfolio provides diversification.
- Funds price their shares as of the close of business at the New York Stock Exchange (4:00 pm EST)
Characteristics of exchange traded funds (ETFs)
- ETFs are open-end investment companies based on an index and traded like stock throughout the business day.
- Can be bought on margin and sold short (like a stock)
- low expenses, are tax efficient, and trade at or very near net asset value.
