© 2000 John Petroff

Questions for Chapter 2 Value Concepts

Review questions

Q-3.1 Is value always stated as an absolute amount? Discuss.
Q-3.2 Does the analytical work end when a value figure is calculated for a given financial asset?

Q-3A.1 Why is calculation of bond prices a direct application of the general value formula?
Q-3A.2 Give the bond price formula.
Q-3A1.1 For major corporate bonds, what published information allows to determine quickly what the yield should be?
Q-3A1.2 List major American bond rating services.
Q-3A1.3 Is there a correspondence between the two major American bond rating services systems? Explain.
Q-3A1.4 What is the highest rating given to a bond?
Q-3A1.5 What is the lowest rating?
Q-3A1.6 Which rating gives a bond an "investment grade"?
Q-3A1.7 Which rating gives a bond a "gilt edge"?
Q-3A1.8 Which rating puts a bond in a speculative investment category?
Q-3A1.9 Which rating indicates that the company that issued the bond, may be or may have been in default?
Q-3A1.10 To find the most recent bond yield quotations, where would one look?
Q-3A1.11 Is it useful to calculate a bond price using the yield for a specific bond published in the financial press to verify and compare with published quotations? Why, or why not?
Q-3A1.12 What are the three main factors that affect the yield of a bond?

Q-3A2.1 How do special provisions in the bond indenture affect the price of a bond?

Q-3A3.1 What are the two types of municipal bonds?
Q-3A3.2 How are municipal bonds rated?

Q-3B.1 Do short term securities have coupon payments?
Q-3B.2 How are short term securities sold?
Q-3B.3 Is it enough to compare yields of short term securities? Or is calculating value also wise?
Q-3B.4 Why are government short term securities considered void of risk?
Q-3B.5 What type of risk is analyzed when evaluating a government security?
Q-3B.6 Why is interest forecasting important in selecting a government security?

Q-3C.1 At what point in time is pricing of a loan conducted?
Q-3C.2 What type of assessment is conducted when a customer is accepted on open account?

Q-3C1.1 What four factors determine the interest charged on a bank loan?
Q-3C1.2 What is the very minimum rate a bank will charge on any loan?
Q-3C1.3 Which two methods are used to calculate a bank's cost of funds?
Q-3C1.4 What is being averages in a bank's average cost of funds?
Q-3C1.5 When will a bank use a marginal cost of acquiring new funds as its cost of funds?
Q-3C1.6 How does the timing of the repayment of a loan affect the rate charged on a loan?
Q-3C1.7 List the different alternatives for loan structure.
Q-3C1.8 What in the loan structure will reduce the rate charged?
Q-3C1.9 How is a loan risk evaluated and incorporated into the rate charged?
Q-3C1.10 List typical elements present in a bank grading matrix.
Q-3C1.11 Do all American banks use the same grading system?
Q-3C1.12 What is a bank's reference rate?
Q-3C1.13 What used to be the term for the interest rate charged by American banks to their best customers?
Q-3C1.14 Why is the term prime rate no longer used?
Q-3C1.15 List various bank fees that are imbedded in rates charged on loans.
Q-3C1.16 How is the fee for maintaining the needed required reserve for a loan charged?
Q- What is the name given to the fee charged for the unused portion of a loan?
Q-3C1.18 How is a bank's profits incorporated into the rate charged on a loan?
Q-3C1.19 When a bank offers a choice of fixed or variable rates, which is higher?
Q-3C1.20 How a bank's profit protected by offering to the borrower the choice of fixed or flexible rates?

Q-3C1.22 What are the names given to upper and lower limits of variable rates?
Q-3C1.21 What is the purpose of floors and ceilings in variable rates?
Q-3C1.23 List non-loan revenue opportunities from borrowers?

Q-3C2.1 Outline how loan reassessing is preformed periodically by banks.
Q-3C2.1 List nine ranks of loan performance commonly used.
Q-3C2.3 How is the loan performance ranking used?
Q-3C2.4 What are typical proportions of loan reserve set up for different loan rankings?
Q-3C2.5 What is the proportion of bad loans in the United States?

Q-3D.1 Is there one stock value formula applicable for all stocks? Discuss.
Q-3D.2 In which case can the valuation of preferred stock be conducted with the formula applicable for bonds?

Q-3D1.1 Give formula of the discounted dividends model without growth.
Q-3D1.2 What assumptions are necessary for the discounted dividends model?
Q-3D1.3 How can the assumption of infinite dividends series for the discounted dividends model be justified?
Q-3D1.4 Explain why the discounted dividends model is applicable to preferred stocks.
Q-3D1.5 What discount rate is used in the discounted dividends model?
Q-3D1.6 In which industries is the discounted dividend model applicable for common stock?

Q-3D2.1 In which industries is the constant growth discounted dividend model applicable?
Q-3D2.1 What approximations are necessary for the constant growth discounted dividends model?
Q-3D2.3 Give formula for constant growth discounted dividends model.

Q-3D3.1 Give formula of the earnings multiple.
Q-3D3.2 Is the earnings multiple approach a simplification compared to discounted dividends model?
Q-3D3.3 What does the P/E ratio contain that is not present in the discounted dividend model?
Q-3D3.4 What relationship exists between earnings multiple and risk adjusted required rate of return?
Q-3D3.5 Do companies in the same industry have similar P/E ratios? Why should that be so?
Q-3D3.6 Do European firms have lower P/E ratios? Discuss.
Q-3D3.7 Give formula for P/E ratio based on dividend payout rate, required rate of return and growth rate.
Q-3D3.8 Explain why chemical companies have lower P/E than pharmaceurical companies.
Q-3D3.9 Explain why utilities have higher P/E than banks.
Q-3D3.10 What does the difference between basic P/E and diluted P/E reveal?

Q-3E.1 What are three types of derivative contracts?
Q-3E.2 Define what is a forward contract.
Q-3E.3 What type of forward contracts are usually arranged with major banks?
Q-3E.4 What is the name given to the process of selling shares that one does not own?
Q-3E.5 What is the major problem with forward contracts?
Q-3E.6 How do futures avoid the problem(s) of forward contracts?
Q-3E.7 List the types of assets for which futures are available.
Q-3E.8 Outline the differences between options and futures.
Q-3E.9 Are most futures and options exercised? How can one avoid having to go through the exercise of an option?
Q-3E.10 State the difference between options and rights or warrants.
Q-3E.11 What are the two elements of the value of an option?
Q-3E.12 How do European options differ from American options? Is the difference material in practice?
Q-3E.13 What is another name for exercise price in the case of options?
Q-3E.14 What is the minimum value of a call option? What is the maximum value?
Q-3E.15 What is the name given to the difference between strike price and market price?
Q-3E.16 How is a call option designated if the stock price is above the market price?
Q-3E.17 How is a call option designated if the stock price is just equal to the market price?
Q-3E.18 How is a call option designated if the stock price is below the market price?
Q-3E.19 Why is the curve representing an option value above the minimum value?
Q-3E-20 What is the minimum value of a put option? What is the maximum value?
Q-3E.21 How is a put option designated if the stock price is above the market price?
Q-3E.22 How is a put option designated if the stock price is just equal to the market price?
Q-3E.23 How is a put option designated if the stock price is below the market price?
Q-3E.24 How does the curve representing a put option move as time approaches the expiration date?
Q-3E.25 Give Black-Scholes formula for call option value.
Q-3E.26 What major determinants of option value does Black-Scholes formula reflect ?
Q-3E.27 Give formula of put option.
Q-3E.28 What causes problems in empirical verifications of Black-Scholes formula?
Q-3E.29 What is necessary to derive put option value from call option value formula.
Q-3E.30 Give put option value formula.
Q-3E.31 What characteristic of most warrants influence their valuation significantly.
Q-3E-32 Explain what determinants enter into the valuation of preemptive rights.
Q-3E.33 Derive the value of a preemptive right.

Q-3F.1 What is the name given to the product of number of outstanding shares by stock market price?
Q-3F.2 When is the concept of total capitalization appropriate for valuation of an entire company?
Q-3F1.1 Which rate of return should be used in valuation of a company in a merger?
Q-3F2.1 Why is a valuation of a company with retained earnings and depreciation, an improvement over a valuation on the basis of dividends?
Q-3F2.2 Give formula for valuation of a company in a merger proposition?
Q-3F3.1 When and why is a sales multiple used for valuation of an entire company?
Q-3F4.1 How is sale growth incorporated in the valuation of an entire company?
Q-3F5.1 How should company sales growth projections be modified for industry factors?

Q-3G.1 How is the valuation of company projects similar to the valuation of an entire company?
Q-3G1.1 What is the name given to the procedure of comparing the discounted value of future benefits to the initial outlay?
Q-3G1.2 What is the name given to the process of selecting projects in which a company should invest?
Q-3G1.3 Give formula for NPV.
Q-3G1.4 State the rules for choosing projects using NPV in the cases of both conflicting and non-conflicting projects.

Q-3G2.1 What is the name given to the approach of calculating a yield from projects?
Q-3G2.2 State the rules for choosing projects using IRR in the cases of both conflicting and non-conflicting projects.

Q-3G3.1 What discount rate should be used in NPV calculation?

Q-3G4.1 When can conflicts between NPV and IRR occur?
Q-3G4.2 When is using linear programming necessary?
Q-3G4.3 Which of NPV or IRR, is recognized as the superior method in capital budgeting?

Q-3G5.1 Give formula for PI.
Q-3G5.2 State rule for selecting projects with PI.

Q-3G6.1 Define cost-benefit analysis.
Q-3G6.2 How does a very low real discount rate or the case when a discount rate cannot be determined, affect cost-benefit analysis?
Q-3G6.3 Why is the cost-benefit analysis used most often in public finance?

Q-3G7.1 Define payback method. State rule for selecting projects.
Q-3G7.2 Why is the payback method theoretically flawed?
Q-3G7.3 When is the payback appropriate to use?
Q-3G7.4 What is a modern version of the payback method?

Q-3H.1 How are human assets valued?
Q-3H.2 How are real estate assets valued?

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Last modified: Jun/01/01

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