Question

e) (5 marks) Common stocks that pay no dividends are generally priced lower than dividend paying stocks. f) (5 marks) There is more uncertainty associated with the future returns of common stocks than with the returns of bonds and preferred stock. g) (5 marks) When interest rates go up, the market price of a bond goes up h) (5 marks) The yield on common stock comes from two sources: the dividend yield and the capital gains yield.

Answer 1

e]

False - Common stocks are priced based on future growth prospects. Although dividends are important for some investors, it cannot be generalized that stocks with no dividends are priced lower than dividend-paying stocks. There are many stocks that pay no dividends, but are priced high due to the company's future growth potential. Examples are Amazon and Uber.

f]

True - Bonds and preferred stock have a fixed interest/dividend component, whereas common stock have no assured returns. Hence, the future returns of common stocks are more uncertain.

g]

False - The price of a bond is the present value of its cash flows, the cash flows being interest payments and principal repayable at maturity. Higher the interest rates, lower the present value of the cash flows, and lower the bond price.

h]

True - The returns on a common stock are composed of dividend returns and capital gain returns.