reading 2

• How is the relationship between present values and future values simplified?

  Using continuous compounding formulas
• What is a pure discount debt instrument?

  A zero-coupon bond
• How does an investor earn interest on a pure discount instrument?

  By the difference between face value and purchase price
• What is the price of a zero-coupon bond with a face value of $1,000 and a yield to maturity of 4%?

  Calculated using present value formulas
• What is the yield to maturity of a bond?

  The discount rate applied to the face value
• How do you infer a bond's yield from its price?

  Using financial calculators
• What should cash outflows and inflows be entered as in financial calculators?

  Outflows as negative, inflows as positive
• What happens to a zero-coupon bond with a negative yield?

  It is priced at a premium
• What is a fixed-coupon bond?

  A bond that pays periodic interest payments
• How is the coupon payment determined for a fixed-coupon bond?

  By the bond's coupon rate and face value
• What is the difference between coupon rate and yield to maturity?

  Coupon rate determines cash payments, yield is implied
• What is the annual payment for a $1,000 bond with a 3% coupon rate?

  $30 each year
• What is the value of a 10-year, $1,000 par value bond with a 10% coupon and 8% yield to maturity?

  $1,134.20
• What is a perpetual bond?

  A bond with no maturity date
• What is an amortizing bond?

  A bond that pays a level amount each period
• How is an annuity payment calculated?

  Using a specific formula or financial calculator
• What is the loan payment for a $2,000 loan at 6% over 13 years?

  Calculated using known variables
• How are equity securities valued?

  As the present value of future cash flows
• What is the key difference between equity and fixed-income securities?

  Equity securities do not mature
• What does preferred stock pay?

  A fixed dividend based on par value
• What is the required return for equity investors?

  The discount rate used to value equity
• How is the value of preferred stock calculated?

  Using the perpetuity formula
• What is the value of a preferred stock with a $5.00 dividend and 8% required return?

  $62.50
• What is common stock's claim on a company's assets?

  A residual claim after all other claims
• How do analysts estimate the value of common stock?

  Using dividend discount models (DDMs)
• What is the Gordon growth model used for?

  Valuing common stock with constant growth
• What is the formula for the Gordon growth model?

  V0 = D1 / (ke - gc)
• What is the assumption of constant growth in dividends?

  Dividends grow at a fixed rate indefinitely
• What is a multistage DDM?

  A model for changing growth rates of dividends
• How do you calculate the present value of expected future dividends?

  By discounting individual cash flows
• What is the significance of discounting in the multistage DDM?

  To find the present value of future cash flows
• What is the value of Terry Corporation's preferred stock with a $9 dividend and 11% return?

  $81.82
• What will Dover Company receive for its $10 million bonds at a 6% yield?

  Less than $10 million
• How can we rearrange relationships in finance?

  To solve for required rate of return
• What is the annualized return for a zero-coupon bond priced at $650?

  Calculated using present value formulas
• What is the yield of an annual coupon bond?

  Calculated based on cash flows and price
• What is the annual coupon rate of the bonds mentioned?

  5%
• What happens to the amount received when issuing bonds if the required yield is higher than the coupon rate?

  It will be less than $10 million
• What is the present value (PV) in the context of fixed-income instruments?

  Current worth of future cash flows
• How can we solve for the required rate of return given a security's price?

  By rearranging relationships among PV and cash flows