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Chapter 7: Q. 1 (page 209)

What basic principle of finance can be applied to the valuation of any investment asset?

Short Answer

Expert verified

Any investment is made by an investor in order to profit from it. As per the risk and return analysis, investor may choose appropriate investment choice that gives good return.

Step by step solution

01

Definition

Present value is the current value of a future income at different time interval. The present value of future income is used to appraise an investment asset.

02

Explanation

The price or value of the bond is equal to the present value of all the future cash inflows. In the case of a stock, the value of the stock is the present value of the dividend. The needed rate of return and investment horizon determine the current value. The present value of the stock may vary due to the prevailing interest rate in the current period.

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Most popular questions from this chapter

Suppose that you decide to play a game. You buy stock by throwing a dice a few times, using that method to select which stock to buy. After ten months you calculate the return on your investment and the return earned by someone who followed “expert” advice during the same period. If both returns are similar, would this constitute evidence in favor of or against the efficient market hypothesis?

“Anytime it is snowing when Joe Commuter gets up in the morning, he misjudges how long it will take him to drive to work. When it is not snowing, his expectations of the driving time are perfectly accurate. Considering that it snows only once every ten years where Joe lives, Joe’s expectations are almost always perfectly accurate.” Are Joe’s expectations rational? Why or why not?

If your broker has been right in her five previous buy and sell recommendations, should you continue listening to her advice?

The Internet is a great source of information on stock prices and stock price movements. Yahoo Finance is a great source for stock market data. Go to http://finance .yahoo.com and click on “Markets,” then “World Indices,” and then the DJI symbol to view current data on the Dow Jones Industrial Average. Click on the chart to manipulate the different variables. Change the time range and observe the stock trend over various intervals. Have stock prices been going up or down over the past day, week, three months, and year?

If you read in the Wall Street Journal that the “smart money” on Wall Street expects stock prices to fall, should you follow that lead and sell all your stocks?
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