Question

1. How is the value of a financial asset determined?
2. Why the required rate of return in valuing a financial asset is affected by the risk involved?
3. Describe three characteristics of a preferred stock.
4. Describe three characteristics of a common stock.

Answer 1

1. The value of a financial asset is determined by discounting of the cash flows associated with the Asset and it will be also adjusted with the growth rate in this cash flows over the years so the overall present value of the financial asset will be determined after ascertainment of cash flow generation ability of the acid and discounting those cash flows at the present value.

2. Required rate of return will be affected by the risk because there will be a lot of risk associated in macro economy as well as micro economy so the return preferential of individual will be changing according to risk because individual will want higher rate of return to compensate for higher risk and vice versa.

3. Three characteristic of preferred stock are that these shares are offering with Limited voting rights, and the shares have preferential claim on asset over common equity, and these shares are also getting paid with mandatory dividend.

4. Three characteristics of common stocks are that these stocks are not having mandatory dividend payment and the stocks will also have the voting rights in the company and they will be treated as the owners of the company and the stocks are having high liquidity because they can be traded on the stock exchanges.