Question

TRUE OR FALSE FOR REST

1. Required and expected returns are used to make investment decisions, while realized returns are used to evaluate investment performance.

2. One of the most fundamental investment decision rules is to make an investment (or buy it) if its required return is greater than its expected return.

3. Conceptually, required returns are linked to values for assets, while expected returns are linked to asset prices.

4. One of the primary differences between asset prices and asset values is that you can actually buy or sell the asset at the price, while the value is a more theoretical number (it's what you think the price should be).

5. Common Stock dividends are determined by the par value of the stock and the contractual dividend rate.

6. Common stock ownership typically carries with it the right to vote on important matters of corporate policy, while preferred stock ownership does not.

7. For any given firm that has both preferred stock and common stock, the common stock will always be safer than the preferred stock since it has much higher potential returns.

8. One reason firms like to borrow money (even though borrowing adds risk to the firm) is that the interest on borrowed money is fully tax deductible, while dividend payments to equity investors are not fully deductible.

Answer 1

1. True - to make decision to invest in an asset, you need to know how much return you require from investment in that asset and what is the expected return from that asset. realized returns are used to evaluate the investment performance by comparing it to your required return and expected return.

2. False - One of the most fundamental investment decision rules is to make an investment (or buy it) if its required return is lower than its expected return.

3. True - to know the value of an asset, you need to discount its future cash flows by your required return. expected returns are based on an asset's current market price. based on current market price of an asset, you can determine its expected return by how much you pay to buy it and what is the present value of its cash flows.

4. True - asset prices are determined by the market based on supply and demand of that asset. asset value is determined by making judgement about macroeconomic factors (interest and inflation rate) and microeconomic factors (future cash flow of the asset , cost of capital etc.). based on your judgement, value of an asset is the price you think should be of that asset. but based on your value of the asset, you can't buy or sell it from/in the market.