Quiz 3

Question 1

What are the pros and cons of the dividend discount model?

Answer 1

Pros: conservative estimate, requires only 3 inputs: next year’s expected dividends, the expected return, and the growth rate of the dividend
Cons: can only be used with companies who issue dividends regularly, if one component of the formula is wrong, makes the answer very off base

Question 2

What are the pros and cons to the two-stage dividend growth model?

Answer 2

Pros: good for companies who experience varying periods of constant and non-constant dividend growth
Cons: inaccurate results are possible if the timing is not estimated properly of when a particular growth rate period should end.

Question 3

What are the pros and cons of the residual income and free cash flow models?

Answer 3

Pros: useful for evaluating companies who do not offer dividends. The present value of all future Residual earnings (Excess of actual earnings over required earnings) is assessed in the calculation instead of dividends, along with the current book value of the firm.
Cons: relies heavily on forward earnings estimates which is vulnerable to bias on the part of the investor, fin. Advisor, and leaves the investor dependent upon the accuracy of financial statements.

Question 4

This model only places valuation on a company’s equity

Answer 4

Dividend discount model

Question 5

This model places value on the total market value of the company’s assets, not just its equity.

Answer 5

Free cash flow model

Question 6

The basic interest rate on short term loans that the largest commercial banks charge to their most credit worth corporate customers.

Answer 6

Prime rate

Question 7

This rate is primarily affected by the federal funds rate and impacts consumers by the way in which it directly affects the lending rates of mortgage, small business and personal loans.

Answer 7

Prime rate

Question 8

The overnight rate that banks lend to each other

Answer 8

Federal funds rate

Question 9

Deposits made in u.s. Dollar denominations outside of the u.s. At foreign banks or foreign branches of u.s. Banks

Answer 9

Eurodollars

Question 10

The average size of a typical Eurodollar deposit is in the _______ and has a maturity rate of less than ___ months

Answer 10

Millions

6

Question 11

True or false: the Eurodollar market is out of reach for most individual investors except through money market funds.

Answer 11

True

Question 12

LIBOR stands for

Answer 12

London Interbank Offered Rate

Question 13

The interest rate that international banks charge one another for overnight Eurodollar loans

Answer 13

LIBOR

Question 14

What is the most frequently quoted rate for representing the London money market?

Answer 14

LIBOR

Question 15

a form of short term debt issued by the u.s. Federal government through the u.s. Treasury

Answer 15

U.s. Treasury bill

Question 16

What is the world’s largest market for new debt securities with one year or less to maturity

Answer 16

U.S. Treasury Bill market

Question 17

What is the top credit market for determining the approximate level of short term interest rates

Answer 17

U.S. Treasury Bill market

Question 18

This represents one percent of one percent in reference to interest rates or bond yields.

Answer 18

Basis Point

Question 19

A form of debt issued by a corporation to investors in which the investors can exchange for the corporation’s common stock set based on a pre-determined amount/conversion ratio

Answer 19

Convertible bond

Question 20

name 3 reasons why corporations issue convertible bonds

Answer 20

1) delays dilution of common stock and EPS
2) lower coupon rate for this kind of bond
3) way to raise a lot of capital even if a credit risk and less expensively than w/ bank loan

Question 21

Investors purchase convertible bonds because

Answer 21

1) benefit of stock-market type high yield with minimized risk associated w/ bonds

Question 22

Debt obligations issued by governmental entities in which the money received for the bonds is used for projects considered to serve the public good.

Answer 22

Municipal bonds

Question 23

True or false: A municipal bond with a lower interest rate than a corporate bond can be more valuable than the corporate bond?

Answer 23

True

Question 24

What are 3 valuation models

Answer 24

1. Dividend discount
2. Two-stage dividend growth
3. Residual income and free cash flow