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BIZ2119

Midterm Homework

Prof. S. Park

MIDTERM HOMEWORK Due 4:00 PM, October 27, Tuesday

True/false questions (1) Bonds with higher liquidity will demand lower interest rates in the market since they can be easily converted into cash on short notice at or near the fair market value for that bond. (2) The existence of an upward sloping yield curve proves that the theory regarding interest rate risk is correct, because an upward sloping curve necessarily implies that firms must offer an interest rate risk premium in order to induce investors to lend for longer periods. (3) There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse).

7-3. Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000, 23 years to maturity, and a coupon rate of 3.8 percent paid annually. If the yield to maturity is 4.7 percent, what is the current price of the bond?

7-8. McConnell Corp. has bonds on the market with 14.5 years to maturity, a YTM of 5.3 percent, a par value of $1,000, and a current price of $1,045. The bonds make semiannual payments. What must the coupon rate be on these bonds?

7-14. An investment offers a total return of 12.3% over the coming year. Janice Yellen thinks the total real return on this investment will be only 8%. What does Janice believe the inflation rate will be over the next year?

7-19. Both Bond Sam and Bond Dave have 7.3% coupons, make semiannual payments, and are priced at par value. Bond Sam has three years to maturity, whereas Bond Dave has 20 years to maturity. If interest rates suddenly rise by 2%, what is the percentage change in the price of Bond Sam? Of Bond Dave? What does this problem tell you about the interest rate risk of longer-term bonds?

BIZ2119

Midterm Homework

Prof. S. Park

7-22. Chamberlain Co. wants to issue new 20-year bonds for some much-needed expansion projects. The company currently has 6 percent coupon bonds on the market that sell for $1,083, make semiannual payments, and mature in 20 years. What coupon rate should the company set on its new bonds if it wants them to sell at par?

8-1. The Jackson-Timberlake Wardrobe Co, just paid a dividend of $2.15 per share on its stock. The dividends are expected to grow at a constant rate of 4% per year indefinitely. a) If investors require an 10.5% return on the stock, what is the current price? b) What will the price be in three years?

8-5. Grateful Eight Co. is expected to maintain a constant 3.7% growth rate in its dividends indefinitely. If the company has a dividend yield of 5.6%, what is the required return on the company’s stock?

8-19. Mobray Corp. is experiencing rapid growth. Dividends are expected to grow at 25% per year during the next three years, 15% over the following year, and then 6% per year indefinitely. The required return on this stock is 10%, and the stock currently sells for $79 per share. What is the projected dividend for the coming year (D1)?

Q1. Nana Milk, a dairy product company, reported EPS of $2.40 in 2019, and paid dividends per

share of $1.06. The earnings and dividends had grown 7.5% a year over the prior five years, and were expected to grow 6% a year in the long term (starting in 2020). The stock’s required return is 12.775%, and the actual P/E ratio is currently 10. a) Estimate the fair P/E ratio for Nana Milk. b) What long-term growth rate is implied in the firm’s current P/E ratio?

BIZ2119

Midterm Homework

Prof. S. Park

< Multiple-choice Questions > 1. A bond that has only one payment, which occurs at maturity, defines which one of the following? A. debenture B. callable C. floating-rate D. junk E. zero coupon 2. A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond? I. discounted price II. premium price III. yield-to-maturity that exceeds the coupon rate IV. yield-to-maturity that is less than the coupon rate A. III only B. I and III only C. I and IV only D. II and III only E. II and IV only 3. Which of the following statements is correct concerning the term structure of interest rates? I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. II. The term structure of interest rates includes both an inflation premium and an interest rate risk premium. III. The real rate of return has minimal, if any, effect on the slope of the term structure of interest rates. IV. The term structure of interest rates and the time to maturity are always directly related. A. I and II only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, and IV only

BIZ2119

Midterm Homework

Prof. S. Park

4. Hardy Lumber has a capital structure which includes bonds, preferred stock, and common stock. Which of the following rights have most likely been granted to the preferred shareholders? I. right to share in company profits prior to other shareholders II. right to elect the corporate directors III. right to vote on proposed mergers IV. right to all residual income after the common dividends have been paid A. I only B. I and III only C. I and IV only D. II, III, and IV only E. I, II, III, and IV

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