The valuation of a financial asset is based on the concept of determining the pr
ID: 2758944 • Letter: T
Question
The valuation of a financial asset is based on the concept of determining the present value of future cash flows. The prices of financial assets are based on the expected value of future cash flows, the discount rate, and past dividends. The discount rate depends on the market's perceived level of risk associated with an individual security. By using different discount rates, the market allocates capital to companies based on their risk, efficiency, and expected returns. In estimating the market value of a bond, the coupon rate should be used as the discount rate. Most bonds promise both a periodic return and a lump-sum payment. The price of a bond is equal to the present value of all future interest payments added to the present value of the principal. When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value. An increase in yield to maturity would be associated with an increase in the price of a bond. You hold a long-term bond yielding 10%. If interest rates fall before you sell the bond, you will sell at a higher price than if interest rates had been constant. The yield to maturity is always equal to the interest payment of a bond. The cost of capital for each source of funds is dependent on current market conditions and expected rates of return. K_e represents an expected return to stockholders as well as a cost to the firm. Retained earnings represent an internal source of funds that is raised without the payment of interest or cost to the firm's stockholders. The use of the optimum capital structure minimizes the cost of capital.Explanation / Answer
1. True
2. True
3. True
4. False. market does not allocate capital. Individual investor allocates capital
5. False. Yield to Maturity is used as the discount rate
6. False . Zero copon bonds only provide lumpsum at maturity
7.True
8.True
9.False. YTM and price are inversely related
10 True
11.False. YTM is euqual to interest rate only when bond sells at par value
12.True
13.True
14. true
15.True
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