FIN 406 HW 1

Consider the three stocks in the following table. Pt represents price at time t, and Qt represents shares outstanding at time t. Stock C splits two-for-one in the last period. P0 Q0 P1 Q1 P2 Q2 A) 80 100 85 100 85 100 B) 40 200 35 200 35 200 C) 80 200 90 200 45 400 Calculate the first period rates of return on the following indexes of the three stocks (t = 0 to t = 1) (a) A market value-weighted index. (b) An equally weighted index.

(a) Total market value at t = 0 is: (59,450 + 29,700 + 112,000) = 201,150 Total market value at t = 1 is: (60,900 + 28,350 + 116,000) = 205,250 Rate of return = (205,250/201,150) - 1 = 2.04% (b) The return on each stock is as follows: Ra = (85/80) - 1 = 0.0625 Rb = (35/40) - 1 = -0.125 Rc = (90/80) - 1 = 0.125 The equally-weighted average is: [0.0625 + (-0.125) + .125]/3 = 2.08%

A municipal bond carries a coupon of 7.25% and is trading at par. What is the equivalent taxable yield to a taxpayer in a combined federal plus state in a 40% tax bracket?

7.25%/(1-.40) = 12.083% = ETY

An investor is in 40% combined federal plus state tax bracket. If corporate bonds offer 7.75% yields, what must municipal bonds offer for investor to prefer them to corporate bonds?

After tax yield on corporate bonds: 0.0775 * (1-.40) = 0.045 Munis must offer at least 4.5%

A T-bill with face value $10,000 and 87 days to maturity is selling at a bank discount ask yield of 3.4%. What is the price of the bill?

Bank discount of 87 days--> 0.034 × (87/360) = 0.008217 Price--> $10,000 × (1 - 0.008217) = $9,917.83

Suppose that short term munis currently offer yields of 4% Find Equivalent Taxable yield of the municipal bond above for tax brackets of zero, 10%, 20%, 30%

Equivalent Tax Yield Formula r = rm/(1-t) a) r = 0.05/(1-0) = 5% b) r = 0.05/(1-.10) = 5.55% c) r = 0.05/(1-.20) = 6.25% d) r = 0.05/(1-.30) = 7.14%