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SMG FE 101 Study Guide - Final Guide: Proxy Fight, High-Yield Debt, Yield Curve

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School
Boston University
Department
Finance
Course
SMG FE 101
Professor
Theodore Chadwick

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Document Summary

E: **the price of the stock = pv of all future expected dividends, plus cash flow from sale in year n, **no growth in dividend > perpetuity: P0 = div1 / re: estimating dividends in div. Discount model: constant dividend growth , assume div will grow at constant rate g forever, value of firm depends on dividend level next year, divided by equity cost of capital adjusted by growth rate. P0 : valuing a firm with constant div growth, dividends vs investment and growth, simple model of growth: the div each year = firm"s earnings per share (eps) x dividend payout rate: *increase dividend in 3 ways: if all increases in future earnings result exclusive from new investment made with, increases earnings, increase dividend payout rate, decrease number of shares outstanding retained earnings, then: Return on new investment: *new investment = firm"s earnings x retention rate, (retention rate: fraction of current earnings firm retains)

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Related Questions

QUESTION 1 The largest investors in corporate bonds are life insurance companies and pension funds. True False 5 points QUESTION 2 Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market. True False 5 points QUESTION 3 The value (or price) of a bond is the present value of its expected future cash flows. True False 5 points QUESTION 4 Bond prices decline when the interest rate decreases. True False 5 points QUESTION 5 The face or par value for bonds is the amount paid to bondholders at maturity and is usually equal to $1,000. True False 5 points QUESTION 6 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. True False 5 points QUESTION 7 Zero coupon bonds have no coupon payments so they sell for more than their par value. True False 5 points QUESTION 8 Interest rate risk is the risk that bond prices will fluctuate when the interest rate changes. True False 5 points QUESTION 9 US Treasury securities are considered risky investments because the coupon payments are unpredictable. True False 5 points QUESTION 10 Bonds are very difficult to value because their future cash flows are very difficult to predict. True False 5 points QUESTION 11 If the bond's coupon rate is equal to the market rate then the bond will sell at a price equal to its face value greater than its face value less than its face value equal to its foreign currency value, e.g., its price in British pounds 5 points QUESTION 12 When calculating the price of a bond that pays a semiannual coupon one needs to use double the number of years until maturity for the number of payments use half the annual coupon payment use half the annual rate of return as the discount rate all of the above 5 points QUESTION 13 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments more than the price of the bond equal to zero equal to the price of the bond less than the price of the bond 5 points QUESTION 14 Which one of the following statements is true? All else equal long-term bonds have lower price volatility than short-term bonds. There is an inverse relation between bond prices and market interest rates. All else equal short-term bonds are more risky than long-term bonds. All else equal US government bonds are more risky than corporate bonds. 5 points QUESTION 15 An investor owns a 10-year US government bond with a 9 percent coupon rate. If the yield-to-maturity on the bond is 8 percent then this bond is selling for its par value. a discount. a premium. its face value. 5 points QUESTION 16 BA Corp is issuing a 10-year bond with a coupon rate of 8 percent and a par value of $1,000. The market interest rate on similar bonds is currently 6 percent. If the coupon payments are made annually, what is the value of this bond? 5 points QUESTION 17 Knight, Inc. has issued a 3-year bond with a $1,000 par value and an annual coupon rate of 6 percent. The current market rate of interest is 5 percent. What is the value of this bond if the coupon payments are made semiannually? 5 points QUESTION 18 Diane Carter is interested in buying a 5-year zero coupon bond with a face value of $5,000. If the market interest rate on these types of bonds is currently 9 percent, what is the current price of this bond? 5 points QUESTION 19 Rudy Sandberg wants to invest in 4-year bonds that are currently priced at $933.76. The bonds have a coupon rate of 6 percent and annual coupon payments. If the par value of the bonds is $1,000, what is the bond's yield-to-maturity? 5 points QUESTION 20 You own a 5-year bond with a face value of $1,000 and a coupon rate of 5 percent with annual payments. The bond is currently worth $810.46. If market interest rates remain unchanged, what will be the value of the bond next year when there are 4 years left until maturity?

All:

Everyone today has to be concerned about being able to retire comfortably when they keep telling us that Social Security will be bankrupt in 2037, a mere 22 years from now, and that it is an entitlement, not something that we and our employers all paid into since we got our first job.

A retirement planner is attached to this message so you can estimate how much money you will need to save to be able to do the things most retirees want to do when they are no longer working.

Then provide your calculations to the class and make a statement as to what you think and if you can achieve it?

For Week 3, please turn in the answers to the following questions:

1. Define the following terms as they apply to bonds:

a. Face value

b. Maturity date

c. Coupon interest (including coupon interest rate)

d. Current yield

e. Yield to maturity (YTM)

f. Yield to call (YTC)

g. Call premium

2. What are “Zero-coupon” bonds?

3. Suppose you see the following bond price quote in the newspaper:

McDonalds 5.7% 2039……..122.733

What can you tell about this bond from reading the price quote?

4. (calculating the present value of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a yield to maturity (YTM) of 4.201%, what should be its price in the bond market (ie, PV)?

5. (calculating the current yield of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its current yield?

6. (calculating the YTM of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its yield to maturity (YTM)?

7. (calculating the YTC of a bond) Assume a callable corporate bond with a face value of $1,000, a coupon interest rate of 5.7%, a market price of $1,223.92, and a call premium of 6%. Assume also that the bond has 24 years to go until it matures, but it is callable after 14 years. What is the bond’s yield to call (YTC)?

8. (calculating the present value of a bond with semi-annual coupon interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a yield to maturity (YTM) of 4.2%, what should be its price in the bond market (ie, PV)?

9. (calculating the YTM of a bond with semiannual interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a market price of $1,223.92, what is its yield to maturity (YTM)?

10. Define the following terms as they apply to interest rates:

a. The real risk-free rate (r*)

b. The nominal risk-free rate (Rrf)

c. The inflation premium (IP)

d. The default risk premium (DRP)

e. The liquidity premium (LP)

f. The maturity risk premium (MRP)

11. Assume the real risk-free rate is 1%. Assume also that inflation is expected to be 1% in the coming year (year 1), 2% in the next year after that (year 2), and 3% in the year after that (year 3). Assume also that the default risk premium, the liquidity premium, and the maturity risk premium are 0%. Given these conditions, what would be the yield on three-year treasury bonds today?

12. Suppose the First Bank of St Louis was offering the following rates on certificates of deposit (CDs) this week:

Maturity Rate

3 month 1.50%

6 month 1.75%

1 year 2.00%

2 year 2.25%

3 year 2.50%

5 year 2.75%

10 year 3.00%

20 year 3.15%

a. Plot the above data on a yield curve. Label the graph and the axes appropriately.

b. Comment on the implications of this curve to you, as a potential investor in CDs.

End of assignment questions

(see answers to numerical problems on the next page)

Answers to numerical problems:

Question 4: $1,223.92

Question 5: 4.66%

Question 6: 4.2%

Question 7: 3.92%

Question 8: $1,225.44

Question 9: 4.21%

Question 11: 3.0%

Hi There

Can you please help with the below question. Thank you in advance.

Ms. Alumm is the portfolio manager for a large insurance company. She is considering investing $1 million to purchase the bonds of Patriot Enterprises, Inc.
[A] All of Patriot's bonds have market prices that imply a yield to maturity of 8% "bond equivalent yield" (that is, 4% every 6-month period).1 Each Patriot bond is described here, based on a
$1,000 face value (par value), which is the promised payment at maturity.

. Bond A has five years until maturity and pays a 9% coupon yield ($45 every 6 months on a $1,000 face value bond).
. Bond B has ten years until maturity, pays an 8% coupon yield ($40 semiannual payments), and is being offered in a private placement at par.
. Bond C is a zero-coupon bond that pays no explicit interest, but will pay the face amount of $1,000 per bond at maturity in ten years.
1. At what price should each bond sell currently?


[B] Ms. Alumm realizes that in addition to determining the current prices of these bonds, she would also like to know how these prices might respond to changing interest rates once her company has purchased them.
2. After purchasing the bonds at an 8% bond-equivalent yield, what would happen to the price of each bond, and how much money would the company make if market yields on Patriot bonds fall to 6%?. . . rise to 10%?


[C] As an alternative, Ms. Alumm has been invited to invest $1 million in a private placement of a 10-year Eurobond2 of a second firm, Nationaliste, S.A. Nationaliste bonds are similar in risk to "Bond B" above: they promise an 8% coupon yield for 10 years, but coupons are paid annually, not semiannually. The Nationaliste bonds are priced at a 1% discount from par, or $990 per $1,000 face value.
3. What yield to maturity is implied by the Nationaliste Eurobond? Compare this yield to the 8% "bondequivalent yield" of the Patriot semiannual coupon bond (Bond B) above. What should Ms. Alumm do?