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Stocks, Bonds, Futures, and Options

1. Why most of the largest stock market declines have occurred in periods when interest rates increased substantially. Please use one of the stock valuation theories to explain this and also provide an intuitive explanation.

a). Find the price of a corporate bond maturing in 5 years that has a 5% coupon (annual payments), a $1,000 face value, and an Aa rating. A local newspaper's financial section reports that the yield on 5-year bonds are : Aaa, 6 percent; Aa,7 percent; and A, 8 percent.

b. If the yield on Aa bonds changes to 8%, what is the bond price?

c. Given the above changes in the price of the bond and the yield, calculate the bond price elasticity.

3. A bond you are interested in pays an annual coupon of 5%, has a yield to maturity of 6% and has 13 years to maturity. The face value is $1,000,000. If interest rates remain unchanged, at what price would you expect this bond to be selling 8 years from now?

4. Company A currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 4% per year. Furthermore, the mean PE ratio of all other firms in the same industry is 15. Company A is expected to pay a dividend of $2 per share over the next four years. The required rate of return on company A's stock is 10%.

a) What is the forecasted stock price of company A in four years? (Hint, use the PE method. You need to figure out the expected earnings per share 4 years from now)

b) Use the adjusted dividend discount model to figure out today's stock price of company A. (Hint: P0 = , P0 is today's price. P4 is the price in 4 years.)

5. Bill purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Bill sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Bill's nominal profit? The par value (size) of the futures contract is $100,000.

6. Today is October 1. Your grandmother has just purchased 100 shares of Microsoft at $50 per share. She plans to give them to you as a Christmas present. However, you intend to sell the shares on Dec. 28 in order to buy a 50" plasma TV with a price of $5000. Your broker provides information about the following options:

Call Put
Exercise Price Dec. Jan. Feb. Dec. Jan. Feb.
$55 1.50 2.00 2.50 6.50 7.00 8.00
$50 2.50 3.50 4.50 1.50 2.50 3.50
$45 6.50 7.50 8.50 1.00 .75 .50
$40 12.50 .75 .50 .25
a. What option would you buy on Oct. 1 to hedge your price risk?
b. What is the total cost of your premium?
c. Suppose the Dec. 28 price of Microsoft is $55. What do you do with your option? What is the net amount of cash that you have for the purchase of the plasma TV?
d. Suppose the Dec. 28 price of Microsoft is $40. What do you do with your option? What is the net amount of cash that you have for the purchase of the plasma TV?

Please see attached.

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Solution Summary

Answers to 6 questions on stock market declines, bond price, bond price elasticity, stock price, futures contract on Treasury bonds, Options.