Fin 310 final

Crane Sporting Goods expects to have earnings per share of $6 in the coming year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations of no growth, Crane's current share price is $60. Suppose Crane could cut its dividend payout rate to 75% for the foreseeable future and use the retained earnings to open new stores. The return on investment in these stores is expected to be 12%. If we assume that the risk of these new investments is the same as the risk of its existing investments, then the firm's required rate of return for its stocks is unchanged. What effect would this new policy have on Crane's stock price?

6/60 + 0 = 0.1 75% of 6 = 4.5 g= 0.25 x 0.12 = 0.3 4.5/(.1-.03) = 64.29$ as opposed to 60$

Consider the data in the following table for a hypothetical two-stock version of the Dow Jones Industrial Average. Stock Initial Final Shares (millions) ABC $30 $40 20 XYZ 70 60 1 a) Calculate the percentage change in the index value. b) Suppose firm XYZ from part (a) were to split two for one during the period (price drops to $35 immediately after the split and the new final price is $30). Calculate the percentage change in the index value. c) If this was for S&P500-type index, what is the percentage change in the index value? Is it affected by the stock split of firm XYZ?

A) Initial value of the index = (30 + 70) / 2 = 50 Final value of the index = (40 + 60) / 2 = 50 There is no change in the index value (0% change). B) We find the new divisor The index value before the stock split = 100 / 2 = 50. (Price of ABC + Price of XYZ)/d = (30 + 35)/d = 50 d = 1.3 The new final value of the price-weighted average = (40 + 30) / 1.3 = 53.85. Percentage change in the index value = (53.85 - 50) / 50 = 0.0769 C) Initial index value = [(30 × 20M) + (70 × 1M)] / 2 = 670M Final index value = [(40 × 20M) + (60 × 1M)] / 2 = 860M Percentage change in the index value = (860M - 670M) / 670M = 0.2836 It is not affected by the stock split of firm XYZ since the value-weighted average index is calculated based on total market values of firms.

a) Johnson Motors' bonds have 10 years remaining to maturity. Coupon interest is paid annually, the bonds have a $1,000 par value, and the coupon rate is 8 percent. The bonds have a yield to maturity of 9 percent. What is the current market price of these bonds? b) BSW Corporation has a bond issue outstanding with an annual coupon rate of 7 percent paid quarterly and four years remaining until maturity. The par value of the bond is $1,000. Determine the fair present value of the bond if market conditions justify a 14 percent annual required rate of return, compounded quarterly.

A) financial calculator: N = 10, I = 9, PMT = 80, FV = 1,000, => PV = $935.82 B) financial calculator: N = 16, I = 3.5, PMT = 17.5, FV = 1,000, => PV = $788.35

Par Value Bond Discount bond Premium bond

coupon rate = YTM coupon rate < YTM coupon rate > YTM

The risk free rate of return is 8 percent; the expected rate of return on the market is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and dividend growth rate of 7 percent, and a current dividend of $2.40. If the stock is selling for $35, what should you do?

CAPM required rate of return = r = .08 + 1.3(.12 - .08) = .132 value of stock = $2.40(1 + .07) / (.132 - .07) = $41.42 Since the stock is selling for $35, it is undervalued and should be purchased.

Duration

Duration describes the percentage price, or present value, change of a financial security for a given (small) change in interest rates.

A bond matures in 2020 and has an annual coupon of 3.65 percent, payable on January 1 and July 1. The current price of the $1,000 bond is $978. On January 30, you purchase $10,000 face amount (settlement date is February 2), and your broker charges a $25 commission. How much must you remit for the purchase?

Since the bond pays $365 a year ($10,000 x 0.0365), the accrued interest owed is $32 (32 days × $365/365). The total that has to be remitted is : $9,780 + 25 + 32 = $9,837.

zero coupon bonds always trade at a coupon bonds trade at a

discount discount or premium

Presently, Stock A pays a dividend of $1.00 a share, and you expect the dividend to grow rapidly for the next four years at 20 percent. Thus the dividend payments will be Year Dividend 1 $1.20 2 1.44 3 1.73 4 2.07 After this initial period of super growth, the rate of increase in the dividend should decline to 8 percent. If you want to earn 12 percent on investments in common stock, what is the maximum you should pay for this stock?

This problem illustrates the supernormal growth dividend valuation model. The present value of the dividends during the period of super growth is as below. $1.20 / (1.12) = $1.07 1.44 / (1.122) = 1.15 1.73 / (1.123) = 1.23 2.07 / (1.124) = 1.32 Sum of PV of dividend during the supernormal growth period = $4.77 The value of the stock at the end of four years (i.e., at the end of the period of supernormal growth): $2.07(1 + .08) / (.12 - .08) = $55.89 The value of the stock for the period after super-growth is the present value of the above valuation: $55.89 / (1.124) = $35.52. Value of the stock is the summation of the two values: $4.77 + 35.52 = $40.29.

If an investor were to anticipate that interest rates were going to fall, that investor should; a. take no action b. buy bonds c. sell bonds d. acquire money market securities

b. buy bonds

The price of a stock is $51. You can buy a six-month call at $50 for $5 or a six-month put at $50 for $2. a) What is the intrinsic value of the call? b) What is the intrinsic value of the put? c) What is the time premium paid for the call? d) What is the time premium paid for the put? e) If the price of the stock falls, what happens to the value of the put? f) What is the maximum you could lose by selling the call covered? g) What is the maximum possible profit if you sell the stock short? * Questions h - k assume the passage of six months. After six months, the price of the stock is $58. h) What is the value of the call? i) What is the profit or loss from buying the put? j) If you had sold the stock short six months earlier, what would your profit or loss be? k) If you had sold the call covered, what would your profit or loss be?

a) $51 - 50 = 1$ b) $50 - 51 = -1 -> cant be negative -> = $0 c) $5 - 1 = $4 d) $2 - 0 = $2 e) Stock price and value of put options are inversely related, so the value of the put would rise f) f. If the investor sells the call covered, the maximum possible loss is the cost of the stock minus the proceeds of the sale of the call: $51 ‑ 5 = $46. g) If the price of the stock fell to $0, the profit (and the maximum possible profit) on the short position is $51. h) The intrinsic value (price) of the call is $58 - 50 = $8. i) The put is worthless; loss is the purchase price: $2 j) The loss would be $51 ‑ 58 = ($7). k) . Profit on the stock: $58 ‑ 51 = $7 Loss of the option: $5 ‑ 8 = (3) Net profit: $4

The time premium paid for an option to buy stock is affected by a. the length of time to expiration b. the existence of a rights offering c. the firm's financial statements d. the firm's credit rating

a. the length of time to expiration

The intrinsic value of an option to buy stock rises as a. the strike price decreases and the price of the stock rises b. the strike price increases and the price of the stock declines c. the strike price decreases and the price of the stock declines d. the strike price increases and the price of the stock rises

a. the strike price decreases and the price of the stock rises

Consider the following. a) What is the duration of a four-year Treasury bond with a 10 percent semiannual coupon selling at par? b) What is the duration of a three-year Treasury bond with a 10 percent semiannual coupon selling at par? c) What is the duration of a two-year Treasury bond with a 10 percent semiannual coupon selling at par? d) Using these results, what conclusions can you draw about the relationship between duration and maturity?

a) D = 3,393.18/1,000 = 3.39 years time cash flow (1+.10/2)t(2) CF/(1+.10/2)t(2) PV of CF x t 0.5 50 .9524 47.62 23.81 1.0 50 .9070 45.35 45.35 1.5 50 .8638 43.19 64.79 2.0 50 .8227 41.14 82.27 2.5 50 .7835 39.18 97.94 3.0 50 .7462 37.31 111.93 3.5 50 .7107 35.53 124.37 4.0 1,050 .6768 710.68 2,842.72 $1,000 $3,393.18 b) Duration on a 3-year bond = 2,664.74/1,000 = 2.66 years c) Duration on a 2-year bond = 1,861.62/1,000 = 1.86 years d) As maturity increases, duration increases but at a decreasing rate.

Calculate the yield to maturity on the following bonds. a) A 9 percent coupon (paid semiannually) bond, with a $1,000 face value and 15 years remaining to maturity. The bond is selling at $985. b) An 11 percent coupon (paid annually) bond, with a $1,000 face value and 6 years remaining to maturity. The bond is selling at $1,065.

a) financial calculator: N = 30, PV= -985, PMT = 45, FV = 1,000, => I = ytm = 4.593% for 6 months or 9.186% per year. B) financial calculator: N = 6, PV= -1,065, PMT = 110, FV = 1,000, => I = ytm = 9.528%

The accrued interest on a bond a. avoids personal income taxation b. is paid by the buyer of the bond to the seller of the bond c. is the result of the possibility of the bond defaulting d. applies only to zero coupon bonds

b. is paid by the buyer of the bond to the seller of the bond

Your firm has a credit rating of A. You notice that the credit spread for five year maturity A debt is 85 basis points (0.85%). Your firm's five year debt has a coupon rate of 6%. You see that new five year treasury notes are being issued at par with a coupon rate of 2.0%. What should the price of your outstanding five year bonds be per $100 of face value?

fv = 1000 n = 5 pmt = 6% of 1,000 = 60 i = 2% + 0.85 % = 2.85% PV= 1144.88