Quiz 3

You are evaluating a company's stock. The stock just paid a dividend of $1.75. Dividends are expected to grow at a constant rate of 5 for long time into the future. The required rate of return (Rs) on the stock is 12 percent. What is the fair present value?

$26.25 P0 = (1.75 × 1.05)/(0.12 − 0.05) = 26.25

A 15-year corporate bond pays $40 interest every six months. What is the bond's price if the bond's promised YTM is 5.5 percent?

1,253.12 Using P/Y2 for semiannual; FV $1,000; PMT $40; N 15 years; and I/Y 5.5 percent. Solve bond price (PV) = $1,253.12. Calculator Method: N = 30 PMT = 40 I/Y = 2.75 FV = 1,000 Solve for PV which is $1,253.12.

A common stock paid a dividend at the end of last year of $3.50. Dividends have grown at a constant rate of 6 percent per year over the last 20 years, and this constant growth rate is expected to continue into the future. The stock is currently selling at a price of $35 per share. What is the expected rate of return on this stock?

16.6% E(Rs) = (3.5 × 1.06/35) + 0.06 = 0.166

A semiannual payment bond with a $1,000 par has a 7 percent quoted coupon rate, a 7 percent promised YTM, and 10 years to maturity. What is the bond's duration?

7.35 years Σ[(t × CFt/(1.035)^t)]/($1,000)

Corporate Bond A returns 5 percent of its cost in PV terms in each of the first five years and 75 percent of its value in the sixth year. Corporate Bond B returns 8 percent of its cost in PV terms in each of the first five years and 60 percent of its cost in the sixth year. If A and B have the same required return, which of the following is/are true? I. Bond A has a bigger coupon than Bond B. II. Bond A has a longer duration than Bond B. III. Bond A is less price-volatile than Bond B. IV. Bond B has a higher PV than Bond A.

II and IV only

How does an increase in interest rates affect a security's duration?

The higher the interest rate the shorter the duration of the security.

Duration is

the weighted average time to maturity of the bond's cash flows.