Consider the following four debt securities, which are identical in every characteristic except as noted:
W: A corporate bond rated AAA
X: A corporate bond rated BBB
Y: A corporate bond rated AAA with a shorter time to maturity than bonds W and X
Z: A corporate bond rated AAA with the same time to maturity as bond Y that trades in a more liquid market than bonds W, X or Y.
[List the bonds in order of its interest rate (yields to maturity) from highest to lowest]
The corporate bond (X) rated BBB would have the highest interest rate.
The (W) bond rated AAA would have the next highest interest rate.
The (Y) bond would have the third highest interest rate since it has a shorter maturity. When bonds have a shorter maturity, the interest rates are not as high. The reasoning behind is this is simple. The investor’s ...view middle of the document...
Nielsen states “The yield curve can help make a wide range of financial decisions. The yield curve reflects the bond market's consensus opinion of future economic activity, levels of inflation and interest rates. It's very difficult to outperform the market, so prudent investors should look to employ valuable tools like the yield curve whenever possible in their decision-making processes. “
One year ago, you bought a bond for $10,000. You received interest of $400 at the end of the year, as well as your $10,000 principal. If the inflation rate over the last year was five percent, calculate the real return.
The nominal return would equal (10,400-10,000)/10,000 = 0.04= 4%. Factor in that inflation was 5%, the real return would equate to -1%. (4%-5%). The investor’s money would be less. Although there was a profit made, the inflation rate resulted in the value of his money being less than the original amount.
Suppose that the price of a stock is $50 at the beginning of a year and $53 at the end of the year, and it pays a dividend of $2 during the year. Calculate the stock’s current yield, capital-gains yield, and the return.
Current yield= $2/$50 = 4%
Capital gains yield = (53-50)/50 = 6%
Return = 4% + 6% = 10%
Use the capital-asset pricing model to predict the returns next year of the following stocks, if you expect the return to holding stocks to be 12 percent on average, and the interest rate on three-month T-bills will be two percent. Calculate a stock with a beta of -0.3, 0.7, and 1.6.
Beta of -0.3= 2% + -0.3(12%-2%) = -1%
Beta of 0.7 = 2% + 0.7(12%-2%) = 9%
Beta of 1.6 = 2% + 1.6 (12%-2%) = 18%
Nielsen, B (2008, April 14). Bond Yield Curve Holds Predictive Powers. Retrieved from http://www.investopedia.com/articles/economics/08/yield-curve.asp#axzz1lYAdxv8y
Fisher, I. How much are stocks worth? Retrieved from http://www.moneychimp.com/articles/valuation/capm.htm