Finance Test 3

A bond issuer is said to be in _____ if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue's restrictive covenants

Default

These Bonds are issued by business firms and are exposed to default risk

Corporate bonds

A bond's ______ refers to the interest payment or payments paid by a bond.

Coupon payment

Ace Products has a bond issue outstanding with 15 years remaining to maturity, a coupon rate of 7.2% with semiannual payments of $36, and a par value of $1,000. The price of each bond in the issue is $1,170.00. The bond issue is callable in 5 years at a call price of $1,072. What is the bond's current yield?

Current Yield= Annual interest payments/Current bond price $72/$1,170 = 6.15%

Dividend Yield

D1 / P0

Corporate bond

Debt security issued by corporation that has promised future payments and a maturity date *typically pay interest to bondholders semiannually

Nazim also recently bought bonds with a clause stating that interest will be paid based on the inflation rate. When the inflation rate increases, the interest on the bonds will also increase. Nazim has invested in ____

Indexed bonds

You are interested in investing in a stock with a required rate of return of 8.16%. The risk free rate is 4.07% and the market risk premium is 4.96%. Calculate the return on the market. You answer should be in percent to two decimals (example 5.03%)

MRP = 4.96% RFR = 4.07% 4.07% + 4.96% (risk premium) = 9.03%

Realized return or Cash Return

Measures the gain or loss on an investment You invested in 1 share of Apple (AAPL) for $95 and sold a year later for $200. The company did not pay any dividend during that period. What will be the cash return on this investment? = Buy for $95 and sell for $200 Cash Return = Ending Price + Dividend - Beg. Price

Copy of Yield to Maturity refers to

The rate of return earned on a bond if it is held to expiration

Bond

long-term contract under which a borrower agrees to make payments of interest and principal on specific dates 1. Treasury = LEAST DEFAULT RISK 2. Corporate 3. State & local government 4. Foreign

Consider an annual coupon bond with a $1000 par value and 5 years to maturity. The coupon rate is 7% and the yield to maturity is 9%. If the yield to maturity is held constant, which of the following can be inferred about this bond?

this bond is selling at a discount and the price will increase with time

Consider an annual coupon bond with a $1000 par value and 5 years to maturity. The yield to maturity is 8% and the coupon rate is 10%. If the yield to maturity is held constant, which of the following can be inferred about this bond?

this bond is selling at a premium and the price will decrease with time

Capital gains yield

(P1 - P0) / P0

Portfolio's Expected Return

-A weighted average of the returns of the portfolio's component assets Assume a two-stock portfolio is created with $50,000 invested in both High Tech and Collections. Portfolio Expected Return = 0.5(9.9%) + 0.5(1.2%) = 5.5%

Puttable Bond

-Allows bondholder to sell bond to issuer early at a pre-specified price and time -Put price typically lower than par -Put period is typically later in the bond's life -Will have a lower interest rate, all else equal (lender pays the attached option)

Callable Bond

-Allows issuer to pay bond off early at a pre-specified price and time (call it in) -Call price typically greater than par -Call period is typically later in the bond's life -Will have a higher interest rate, all else equal (borrower pays the attached option)

Zero-coupon bonds

-Coupon rate of 0% -Par repayment is only cash flow -Sell at a discount -All else equal, have greater interest rate risk

Convertible Bond

-Gives the bondholder the ability to convert the bond into a specified number of shares of the issuer's stock -Will have a lower interest rate, all else equal (lender pays the attached option) EX: Innovative Energy LLC is a start-up company that just raised $100,000 to conduct a third-party feasibility study on its business model. The company agreed to treat the $100,000 investment as debt at 10% interest rate; however, the investor has the right to exchange the debt for common stock during the company's next financing round. Which of the following terms best describes the $100,000 investment? -Convertible bond

Market Risk

-Portion of a security's stand-alone risk that cannot be eliminated through diversification -Measured by beta

Expected return

-Rate of return that the investor expects to earn from an investment in the future To calculate: -Multiply "Probability" and "High Tech" for all the economy options -Then you add all of the products up to get the Expected Return

Diversification

-Strategy designed to reduce risk by spreading a portfolio across many assets

Discount Rate

-should reflect the risk of the cash flows -"market rate" -rate changes when market conditions change EX: When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at a discount

How to measure risk: 1. Variance 2. Standard deviation

1. -Average squared deviation from the mean -The higher the variance, the higher the risk 2. -Square root of variance

Alderaan Incorporated has just paid a dividend of $4.81. The firm's current price on common stock is $76.86. Dividends are expected to grow at a 4% constant rate. What is the firm's cost of common equity? Give your answer as a percentage, rounded to two decimal places (example: 9.58% as 9.58)

10.26%

Lucas Corp bonds have 13 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 9% and the bond is currently selling for $904. What is the bond's yield to maturity?

10.38%

Alderaan Incorporated has a current stock price of $26.07. The last dividend was at 2.04, and is expected to grow at a 3% constant rate. What is the firm's cost of common equity? Give your answer as a percentage, rounded to two decimal places (example: 9.58% as 9.58)

10.83%

B.D. Howard Corp bonds have 11 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 9% and the bond is currently selling for $840. What is the bond's yield to maturity?

11.65%

This is the Way Companies has common stock with a beta of 1.58, if the risk free rate of return is expected to be 4.2% and the market rate of return is 15%, what is the required return on This is the Way's common stock?

21.26

This is the Way Companies has common stock with a beta of 1.85, if the risk free rate of return is expected to be 5.2% and the market rate of return is 14%, what is the required return on This is the Way's common stock?

21.48

Dividend Discount Model EX: What is the value of a share of common stock that paid $6 dividend at the end of last year and is expected to pay a cash dividend every day from now to infinity, with that dividend growing at a rate of 5% per year, if the investors required rate of return is 12% on that stock?

6 x 1.05 = 6.30 (D1) 6.3 / .07 = 90 (RRR)

Alderaan Incorporated has just paid a dividend of $3.27. The firm's current price on common stock is $44.52. Dividends are expected to grow at a 2% constant rate. What is the firm's cost of common equity?

9.35%

D. Chow Director Corp bonds have 12 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 9% and the bond is currently selling for $943. What is the bond's yield to maturity?

9.83%

In July 2009, Walmart sold 100 billion yen of five-year samurai bonds. Lead managers in the deal were Mizuho Securities, BNP Paribas, and Mitsubishi UFJ Securities. Issuer of bond? What type of bonds are these?

= Walmart =Corporate bonds

If the risk free rate is 3% , the return on the market is 8% and beta is 1.2 , what is the required rate of return on the firm's stock?

=3% + 1.2 x (8% - 3%) =.03 + 1.2 x (.08 - .03) =.03 + 1.2 x (.05) =.03 + .06 =.09 ~ 9%

Rate of Return

=Cash Return/Beginning Price

Stand-alone Risk

=Market risk + Diversifiable risk -Portion of a security's stand-alone risk that can be eliminated through proper diversification

Recently, Flowers Food had a Beta of 0.79. What can you conclude form this information? A) 0.79% of the firm's risk cannot be diversified away B) This stock yields a 0.79% required returns C) This stock has less systematic risk than the average stock in the market D) This stock has higher systematic risk that the average stock E) The market value of the stock is 21% below the intrinsic value

C) This stock has less systematic risk than the average stock in the market

A bond's ______ gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions

Call provision

Total Return

Dividend yield + Capital gains yield

Calculate the rate of Return: Duke Energy: Beg Price= 16.38 Ending Price= 15.82 Cash (dividend)= 1.16 Sears Holdings: Beg Price= 57.74 Ending Price= 67.86 Cash (dividend)= 0.00 Walmart: Beg Price= 55.81 Ending Price= 49.68 Cash (dividend)= 1.06

Duke: 15.82 + 1.16 = 16.98 16.98 - 16.38 = $00.60 (Return in $) .60 / 16.38 = 3.66% (Rate of Return) Sears: 67.86 - 57.74 = $10.12 (Return in $) 10.12 / 57.74 = 17.53% (Rate of Return) Walmart: 49.68 + 1.06 = $50.74 50.74 - 55.81 = -$5.07 (Return on $) -5.07 / 55.81 = -9% (Rate of Return)

Recently, Flowers Food had a Beta of 1.19. What can you conclude form this information? A) This stock yields a 19% required returns B) 19% of the firm's risk cannot be diversified away C) The market value of the stock is 19% below the intrinsic value D) This stock has lower risk than the average stock in the market E) This stock has higher systematic risk than the average stock

E) This stock has higher systematic risk than the average stock

If the coupon interest rate is 4.375% for the first six months and changes to a rate equal to the 10-year Treasury bond rate plus 1.3% thereafter, the bond is called a ____ bond

Floating rate

Default premium

Higher interest rate to compensate the bondholder for the risk of default EX: When the bond's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will exceed its par value, and the bond will trade at a premium

Potter Industries has a bond issue outstanding with an annual coupon of 6% and a 10-year maturity. The par value of the bond is $1,000. If the going annual interest rate is 8.8%, what is the value of the bond? Do not round intermediate calculations. Round your answer to the nearest cent.

N= 10 I/Y= 8.8 PV= ? PMT= 60 (6%x1000) FV= 1,000 PV= $818.71

Ace Products has a bond issue outstanding with 15 years remaining to maturity, a coupon rate of 7.2% with semiannual payments of $36, and a par value of $1,000. The price of each bond in the issue is $1,170.00. The bond issue is callable in 5 years at a call price of $1,072. What is the bond's nominal annual yield to call (YTC)?

N= 10 (5x2) I/Y= ? PV= -1,170 PMT= 36 (7.2%x1,000/2) FV= 1,072 I/Y= 4.65% (2.3232x2)

D. Chow Director Corp bonds have 12 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 9% and the bond is currently selling for $943. What is the bond's yield to maturity?

N= 12 I/Y= ? PV= -943 PMT= 90 (9%x1000) FV= 1000 I/Y= 9.83%

Potter Industries has a bond issue outstanding with a 6% coupon rate with semiannual payments of $30, and a 10-year maturity. The par value of the bond is $1,000. If the going annual interest rate is 8.8%, what is the value of the bond? Do not round intermediate calculations. Round your answer to the nearest cent.

N= 20 (10x2) I/Y= 4.4 (8.8/2) PV= ? PMT= 30 (6%x1,000/2) FV= 1,000 PV= $816.30

Madsen Motors's bonds have 24 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 7%, and the yield to maturity is 9%. What is the bond's current market price? Round your answer to the nearest cent.

N= 24 I/Y=YTM= 9 PV= ? PMT= 70 (7%x1,000) FV= 1,000 PV= $805.87

Nesmith Corporation's outstanding bonds have a $1,000 par value, a 6% semiannual coupon, 13 years to maturity, and an 8% YTM. What is the bond's price? Round your answer to the nearest cent.

N= 26 (13x2) I/Y= 4 (8/2) PV= ? PMT= 30 (6%x1,000/2) FV= 1,000 PV= $840.17

Ace Products has a bond issue outstanding with 15 years remaining to maturity, a coupon rate of 7.2% with semiannual payments of $36, and a par value of $1,000. The price of each bond in the issue is $1,170.00. The bond issue is callable in 5 years at a call price of $1,072. What is the bond's nominal annual yield to maturity (YTM)?

N= 30 (15x2) I/Y= ? PV= -1,170 PMT= 36 (7.2%x1,000/2) FV= 1,000 I/Y= 5.52% (2.7594x2)

Filoni Corp bonds have 8 years remaining to maturity. Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 10% and the bond is currently selling for $1143. What is the bond's yield to maturity?

N=8 I/Y= ? PV= -1143 PMT= 100 (10%x1000) FV= 1000 I/Y= 7.55%

Interest rate risk (price risk)

Risk associated with price fluctuations caused by interest rate changes -Price moves indirectly with interest rates -Longer-term bonds have greater interest rate risk -Lower-coupon bonds have greater interest rate risk -If a bond is held to maturity, interest rate risk is irrelevant

Default risk

Risk issuer won't make payments as specified in the contract -not paying the full amount -not paying at the appropriate time

Reinvestment risk

Risk that rd will fall, and future CFs will have to be reinvested at lower rates, hence reducing income

A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year is called a _____

Sinking fund provision

"Par value" refers to

The face value of a bond

Yield to Call refers to

The rate of return earned on a bond when it is called before its maturity date

Coupon Interest Rate refers to

The stated annual interest rate on a bond

Consider an annual coupon bond with a $1000 par value and 5 years to maturity. The yield to maturity is 10% and the coupon rate is 13%. If the yield to maturity is held constant, which of the following can be inferred about this bond?

This bond is selling at a premium and the price will decrease with time

Under what circumstances would a firm be more likely to buy the required number of bonds in the open market as opposed to using one of the other procedures?

When interest rates are higher than they were when the bonds were issued

A firm's bonds have a maturity of 10 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 5 years at $1,051.70, and currently sell at a price of $1,100.85. What are their nominal yield to maturity and their nominal yield to call? Do not round intermediate calculations. Round your answers to two decimal places.

YTM: N= 20 I/Y= ? PV= -1,100.85 PMT= 40 FV= 1,000 YTM= 6.61% YTC: N= 10 I/Y= ? PV= -1,100.85 PMT= 40 FV= 1,051.70 YTC= 6.50% *Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM

Market > Coupon rate

price < par (bond sells at a discount)

Market = Coupon rate

price = par

Market < Coupon rate

price > par (bond sells at a premium)

Par Value

stated face value or maturity value, and its coupon interest rate is the stated annual interest rate on the bond

The Original Maturity refers to

the number of years to maturity at the time the bond is issued

The Maturity Date refers to

the specified date on which the par value of a bond must be repaid

"Coupon payment" refers to

the specified number of dollars of interest paid each year