O Ch - JustAnswer
o Ch. 5: Problems A1, A10, A12, A14, B16, B18, & B20
o Ch. 7: Problem C1
|A1. |(Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond's|
| |coupon rate is 7.4%. What is the fair value of this bond? |
The Price of the bond = Sum pf the PV of coupon payments + PV of the par value of the bond. You can use the following formula to calculate the price, but for simplicity for similar problems I will use the calculator solutions
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= $481.294 + $414.643
= $895.94
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CALC: n = 10 x 2 r = 9% / 2 PV = ? PMT = 7.4% x 1,000 / 2 = 37 FV = 1,000 PV = -$895.94
|A10. |(Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are|
| |expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value|
| |of a share of RHM stock if the required return on RHM common stock is 10%? |
P0 = D1 / (r - g) = $5.60 / (0.10 - 0.06) = $140.00
|A12. |(Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is |
| |nongrowing. What is the required return on James River preferred stock? |
PVPerpetuity = D / r = D / PV = $3.38 / $45.25 = 7.47%
|A14. |(Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1.00 quarterly |
| |dividend and has a required return of 12% APR (3% per quarter). What is the stock worth? |
PVPerpetuity = D / r = $1.00 / 0.03 = $33.33
|B16. |(Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose PhilEl's |
| |bonds have identical coupon rates of 9.125% but that one issue matures in 1 year, one in 7 years, and the third in 15 |
| |years. Assume that a coupon payment was made yesterday. |
| |a. If the yield to maturity for all three bonds is 8%, what is the fair price of each bond? |
| |b. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of |
| |each bond now? |
| |c. Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what |
| |is the fair price of each bond? |
| |d. Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for |
| |longer-versus shorter-maturity bonds? |
a. 1. CALC: n = 1 x 2 = 2 r = 8% / 2 = 4% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,010.61
2. CALC: n = 7 x 2 = 14 r = 8% / 2 = 4% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,059.42
3. CALC: n = 15 x 2 = 30 r = 8% / 2 = 4% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,097.27
b. 1. CALC: n = 1 x 2 = 2 r = 7% / 2 = 3.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,020.18
2. CALC: n = 7 x 2 = 14 r = 7% / 2 = 3.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,116.03
3. CALC: n = 15 x 2 = 30 r = 7% / 2 = 3.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,195.42
c. 1. CALC: n = 1 x 2 = 2 r = 9% / 2 = 4.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,001.17
2. CALC: n = 7 x 2 = 14 r = 9% / 2 = 4.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,006.39
3. CALC: n = 15 x 2 = 30 r = 9% / 2 = 4.5% PV = ? PMT = 9.125% x 1,000 / 2 = $45.625 FV = $1,000
PV = -$1,010.18
d. Interest-rate risk varies directly with maturity. The longer maturity of the bonds, the larger the price change is when interest rates change.
|B18. |(Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principal in 10 years. |
| |You pay only $500 for the bond. |
| |a. You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders |
| |receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment? |
| |b. The firm does far better than expected and bondholders receive all of the promised interest and principal payments.|
| |What is the realized return on your investment? |
CALC: n = 3.5x2 =7 r = ? PV = -$500 PMT = 9.5%x1,000/ 2= $47.50 FV = $150 - 47.50 = $102.50
r = -2.8746%
APY = (1 + r)m – 1 = (1 - 0.0278)2 – 1 = -5.6666%
YTM = 2x(-2.8746) = -5.7493% APR
b. CALC: n = 10x2 =20 r = ? PV = -$500 PMT = 9.5%x1,000/2 = $47.50 FV = $1,000 r = 11.0489%
APY = (1 + r)m – 1 = (1 + 0.110489)2 – 1 = 23.3185%
YTM = 2x11.0489 = 22.0977% APR
|B20. |(Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, |
| |an analyst for A. G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and |
| |that the dividend will increase 6% annually thereafter. Bret Kimes, one of James' colleagues at the same firm, is less|
| |optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be $1.00, and|
| |that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%. |
| |a. What value would James estimate for this firm? |
| |b. What value would Bret assign to the Medtrans stock? |
a. P1 = D2 / (r - g) = $1.00 / (0.13 - 0.06) = $14.29
P0 = $14.29 / (1 + 0.13)1 = $12.64
b. P3 = D4 / (r - g) = $1.00 / (0.13 - 0.04) = $11.11
P0 = $11.11 / (1 + 0.13)3 = $7.70
Chapter 7
C1)
(Beta and required return) The riskless return is currently 6% and Chicgo Gear has estimated the contingent returns given here.
a. Calculate the expected returns on the stock market and on Chicago Gear stock.
b. What is Chicago Gear’s beta?
c. What is Chicago Gear’s required return according to the CAPM?
Realized Return
State of the Market Probability that state occurs Stock Market Chicago
Stagnant .20 &n bsp; (10%) (15%)
Slow growth .35 &nb sp; 10 15
Average Growth .30 &n bsp; 15 25
Rapid Growth & nbsp; .15 25 35
a. E(R) = Probability of each state * E(Rm) for each state:
E(Rm) = 0.20*10 + 0.35*10 + 0.30*15 + 0.15*25 = 11.73%
E(Rcg) = 0.20*15 + 0.35*15 + 0.30*25 + 0.15*35 = 17.97%
| | |REALIZED RETURN |REALIZED RETURN |
|State of Market |Probability of state |Stock Market |Chicago Gear |
|Stagnant |0.2 |-10% |-15% |
|Slow growth |0.35 |10 |15 |
|Average growth |0.3 |15 |25 |
|Rapid Growth |0.15 |25 |35 |
b. βcg = cov cg, m/σ2m = 180/121 = 1.49
c. Chicago Gear’s required rate of return according to CAPM:
Rcg = Rf + βcg(Rm-Rf)
Rcg = .06 + 1.49 * (.0975-.06)
= .1158
= 11.58%
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