BUSN379 Homework Week 3

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BUSN379 Homework Week 3
If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond…

 

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BUSN379 Homework Week 3

BUSN379 Homework Week 3

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Chapter 6: 16

Chapter 7: 11 and 12

Instructions:

  • Please submit your homework using this template.
  • If you used excel for your calculations, please fill in your results in this template and submit along with your Excel sheet.
  • If you used a financial calculator, provide your inputs.
  • If you used an online calculator, provide a snapshot at all possible.
  • If you used a formula, write down your step-by-step calculations.
  • Please complete all items highlighted in yellow.

Note: you will not receive credit for items without calculations

Chapter 6, Exercise #16: Both Bond Bill and Bond Ted have 7 percent coupons, make semiannual payments, and are priced at par value. Bond Bill has 3 years to maturity, whereas Bond Ted has 20 years to maturity.

(a) If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Bill? Of Bond Ted?

If the bonds were priced at par value, the initial price was $1,000. $1,000 is the “default” face value (par price) of a bond unless otherwise stated.

In order to find the current price, you can:

  1. Compute the present value (which equals the price) of the bond following Example 6.3 on Page 174 of your textbook. Note that the coupon is $35 (7% coupon rate = $70/2 = $35. It is divided by two because it is paid semiannually)….
  2. (b) If rates were to suddenly fall by 2 percent instead, what would the percentage change in the price of Bond Bill be then? Of Bond Ted? Illustrate your answers by graphing bond prices versus YTM.
  3. (c) What does this problem tell you about the interest rate risk of longer-term bonds?

Chapter 7, Exercise #11: E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will pay a $20 dividend per year, but the first dividend will not be paid until 20 years from today. If you require a return of 8 percent on this stock, how much should you pay today?

Here you should make two calculations. The first one is to compute the price of the stock at Year 19, since no dividends will be paid until Year 20. Since this is preferred stock, you will use the following formula:

Pt = Dt+1 / R

Chapter 7, Exercise #12: Alexander Corp. will pay a dividend of $2.72 next year. The company has stated that it will maintain a constant growth rate of 4.5 percent a year forever.

(a) If you want a return of 12 percent, how much will you pay for the stock?

(b) What if you want a return of 8 percent?

(c) What does this tell you about the relationship between the required return and the stock price?