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Earning a return; price of bond; estimated per-share price

1) As an investment analyst, you are typing to determine the probability of different returns on Omega Corporation's common stock. As a first step you will determine Omega's required rate of return. The 10-year Treasury bond rate is 4%. The market risk premium is 5% and Omega's beta is 1.4. You have already completed calculations that indicate Omega's expected rate of return is 13% with a standard deviation of 8%.

a) Determine the probability of earning a return.
b) Determine the probability of earning a negative return.
c) Explain whether or not you would advise an investor to buy Omega's common stock.

2) Doisneau 20-year bonds have a 10% annual coupon interest, make interest payments on a semi-annual basis, and have $1,000 par value. If the bonds are trading with a 12% market's required yield to maturity, is the bond a premium or discount bond? Explain your answer. What is the price of the bond?

3) Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, a maturity premium of 0.08% per year to maturity applies, i.e., MRP=0.08% (t), where t is the years to maturity. Suppose also that a liquidity premium of 0.5% and a default risk premium of 0.85% apply to A-rated corporate bonds. Determine the rate required for the 5 year Treasury bond and the 5 year A-rated corporate bond.

4) Five years ago, XYZ International issued some 30-year zero coupon bonds that were priced with a market's required yield to maturity of 8%. What did these bonds sell for when they were issued? Now that five years have passed and the market's required yield to maturity on these bonds has climbed to 10%, what are they selling for? If the market's required yield to maturity had fallen to 6%? what would they have been selling for?

5) An analyst is estimating the intrinsic value of Harkleroad Technologies' stock.
Harkelroad's free cash flow is expected to be $25 million this year, and grow at a rate of 20% for the next 3 years and thereafter at a constant growth rate of 7%. The company's cost of money is 10%. Harkleroad has $200 million of long-term debt and preferred stock, and 30 million outstanding shares of common stock. What is the estimated per-share price of Harkleroad Technologie's common stock?

Solution Preview

Please see the attachment.

1) As an investment analyst, you are typing to determine the probability of different returns on Omega Corporation's common stock. As a first step you will determine Omega's required rate of return. The 10-year Treasury bond rate is 4%. The market risk premium is 5% and Omega's beta is 1.4.

Using CAPM, the return is
Return = Rf + (Rm-Rf) beta
Rf = risk free rate = T bond rate = 4%
(Rm-Rf) = market risk premium = 5%
Return = 4% + 5% X 1.4 = 11%

You have already completed calculations that indicate Omega's expected rate of return is 13% with a standard deviation of 8%.

a) Determine the probability of earning a positive (the word positive should be here) return.

The probability can be seen from the normal distribution. The mean return is 13% and the standard deviation is 8%. We would have all positive return on the right side of the graph since they would be above 8%. On the left side, positive returns would be till 13%/8% = 1.625 times standard deviation since 8% X 1.625 = 13% and beyond this the return would turn negative. We find the probability of returns being 1.625 times the standard deviation (see the standard normal probability distribution for z=1.63) and this comes to 0.4484. The probability of right side is 0.5. Total probability of positive return is 0.5+0.45 = 0.95 or 95%

b) Determine the probability of earning a negative return.

The probability of earnings negative return = 1-0.95 = 0.05 or ...

Solution Summary

The probability of earning a return, price of a bond and the estimated per-share price are determined. The expert explains whether or not you would advise an investor to buy Omega's common stock is determined.

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