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Text Problem Sets and Concept and Principles Summary

FIN 571

Text Problem Sets and Concept and Principles Summary

Problem A3: (Bond valuation) General Electric made a coupon payment yesterday on its 6.75% bonds that mature in 8.5 years. If the required return on these bonds is 8% APR, what should be the market price of these bonds?

PMT -33.75

FV -1000

N 17

Rate 4%

Market Price $923.96

Fair Value of a bond = C/r*(1-1/(1+r)^n)+M/(1+r)^n

Assuming that it’s a semi-annual bond with face value of $1000

A13. (Required return for a preferred stock) Sony $4.50 preferred is selling for ...view middle of the document...

What is the fair price of each bond now?

Suppose that in the second hour of trading, the yield to maturity of all these bonds changes

once more to 8%. Now what is the fair price of each bond?

Based on the price changes in response to the changes in yield to maturity, how is interest-rate risk a function of the bond’s maturity? That is, is interest-rate risk the same for all four bonds, or does it depend on the bond’s maturity?

a) Yield to maturity is 9%

Bond Mature in 2 Year Bond Mature in 5 Year Bond Mature in 10 Year Bond Mature in 20 Year

FV 1000 FV 1000 FV 1000 FV 1000

N 2 N 5 N 10 N 20

PMT 72.5 PMT 72.5 PMT 72.5 PMT 72.5

YTM 9.00% YTM 9.00% YTM 9.00% YTM 9.00%

PV -$969.22 PV -$931.93 PV -$887.69 PV -$840.25

Fair Price $969.22 Fair Price $931.93 Fair Price $887.69 Fair Price $840.25

b) Yield to maturity is 10%

Bond Mature in 2 Year Bond Mature in 5 Year Bond Mature in 10 Year Bond Mature in 20 Year

FV 1000 FV 1000 FV 1000 FV 1000

N 2 N 5 N 10 N 20

PMT 72.5 PMT 72.5 PMT 72.5 PMT 72.5

YTM 10.00% YTM 10.00% YTM 10.00% YTM 10.00%

PV -$952.27 PV -$895.75 PV -$831.02 PV -$765.88

Fair Price $952.27 Fair Price $895.75 Fair Price $831.02 Fair Price $765.88

c) Yield to maturity is 8%

Bond Mature in 2 Year Bond Mature in 5 Year Bond Mature in 10 Year Bond Mature in 20 Year

FV 1000 FV 1000 FV 1000 FV 1000

N 2 N 5 N 10 N 20

PMT 72.5 PMT 72.5 PMT 72.5 PMT 72.5

YTM 8.00% YTM 8.00% YTM 8.00% YTM 8.00%

PV -$986.63 PV -$970.05 PV -$949.67 PV -$926.36

Fair Price $986.63 Fair Price $970.05 Fair Price $949.67 Fair Price $926.36

d) The fair price computed above that the interest rate risk increase as the maturity period increases.

B17. (Default risk) You buy a very risky bond that promises an 8.8% coupon and return of the $1,000 principal in 10 years. You pay only $500 for the bond.

You receive the coupon payments for two years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 2.5 years. What is the realized return on your investment?

CALC: n = 2.5 x 2 =5 r = ? PV = -$500 PMT = 8.8% x 1000 / 2 = $44

FV = $150 - 44 = $106 r = -10.72%

APY = (1 + r)m - 1

APY = (1 - 0.1072)2 - 1

APY = -20.29%

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 = 10 x 2 =20 r = ? PV = -$500 PMT = 8.8% x 1000 / 2 = $44 FV = $1000

r = 10.46%

APY = (1 + r)m - 1

APY = (1 + 0.1046)2 - 1

APY = 22.01%

B12 .

(CAPM) Owego Storage and Housing, Inc., is considering building a new warehouse in Endicott, New York. Owego Storage has 2 million common shares outstanding. The share price is $11. Assume rf = 4.5%, β = 0.75, and...

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