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# Bond calculations and bond risks

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This assignment contains two parts: Part I and Part II.

Part I

1. Assume that the company that you selected for the Module 1 SLP has a bond outstanding that matures in 20 years and has a coupon rate of 6.5%. The par value of the bond is \$1,000.
a. If the yield to maturity is 8% and the bond pays interest on an annual basis, what's the current price of the bond? Is the bond selling for a premium or discount? How can you tell?
b. If the yield to maturity is 8% but the bond pays interest on a semi-annual basis instead of an annual basis, what's the current price of the bond? Is it different from the value when using annual compounding? Explain.
c. Now, assume that the economy enters into a recession and interest rates fall. The bond's yield to maturity is now 5%. What's the bond's new price? How does the price compare with your answer in part a? Why did the bond's value change?
2. A bond matures in ten years and is currently selling for \$1,125. The bond pay interest annually, has a par value of \$1,000, and a yield to maturity of 10.75%. What's the bond's current yield?

Part II:

Write a 2-page essay comparing reinvestment risk and interest rate risk and how an investor can protect his or her portfolio from those risks. Please be sure to discuss duration in your paper.

Please submit your assignment and interpret the results. The complete assignment should be 3-4 pages.

SLP Assignment Expectations

You are expected to:
Describe the purpose of the report and provide a conclusion. An introduction and a conclusion are important because many busy individuals in the business environment may only read the first and the last paragraph. If those paragraphs are not interesting, they never read the body of the paper.

#### Solution Summary

This solution provides calculations for bond problems and an overview of reinvestment risk and interest rate risk with strategies to mitigate them

\$2.19

## Financial Assets

1. The Carter Company's bonds mature in 10 years have a par value of \$1,000 and an annual coupon payment of \$80. The market interest rate for the bonds is 9%. What is the price of these bonds?

a. \$935.82
b. \$941.51
c. \$958.15
d. \$964.41
e. \$979.53

2. Bauer Inc's bonds currently sell for \$1,275 and have a par value of \$1,000. They pay a \$120 annual coupon and have a 20-year maturity, but they can be called in 5 years at \$1,120. What is their yield to maturity (YTM)?

a. 8.78%
b. 8.99%
c. 9.15%
d. 9.33%
e. 9.41%

3. You intend to purchase a 10-year, \$1,000 face value bond that pays interest of \$60 every 6 months. If your nominal annual required rate of return is 10% with semiannual compounding, how much should you be willing to pay for this bond?

a. \$ 826.31
b. \$1,086.15
c. \$ 957.50
d. \$1,431.49
e. \$1,124.62

4. An investor has a 2-stock portfolio with \$50,000 invested in Palmer Manufacturing and \$50,000 in Nickles Corporation. Palmer's beta is 1.20 and Nickles' beta is 1.00. What is the portfolio's beta?

a. 0.94
b. 1.02
c. 1.10
d. 1.18
e. 1.26

5. Miller Inc. is considering a capital budgeting project that has an expected return of 10% and a standard deviation of 30%. What is the project's coefficient of variation?

a. 1.8
b. 2.2
c. 2.6
d. 3.0
e. 3.4

6. Niendorf Corporation's stock has a required return of 13.00%, the risk-free rate is 7.00%, and the market risk premium is 4.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2.00%. What is Niendorf's new required return?

a. 14.00%
b. 15.00%
c. 16.00%
d. 17.00%
e. 18.00%
7. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.)

a. 10.50%
b. 11.00%
c. 11.50%
d. 12.00%
e. 12.50%

8. Which of the following statements is CORRECT?
a. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
b. Portfolio diversification reduces the variability of returns on an individual stock.
c. When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
d. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.
e. The SML relates its required return to a firm's market risk. The slope and intercept of this line cannot be controlled by the financial manager.

9. You observe the following information regarding Company X and Company Y:

? Company X has a higher expected return than Company Y.
? Company X has a lower standard deviation of returns than Company Y.
? Company X has a higher beta than Company Y.

Given this information, which of the following statements is CORRECT?

a. Company X has a lower coefficient of variation than Company Y.
b. Company X has more company-specific risk than Company Y.
c. Company X's stock is a better buy than Company Y's stock.
d. Company X has less market risk than Company Y.
e. Company X's returns will be negative when Y's returns are positive.

10. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

a. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
b. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
c. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
d. The effect of a change in the market risk premium depends on the level of the risk-free rate.
e. The effect of a change in the market risk premium depends on the slope of the yield curve.

11. If D0 = \$2.00, g (which is constant) = 6%, and P0 = \$40, what is the stock's expected dividend yield for the coming year?

a. 5.0%
b. 5.1%
c. 5.3%
d. 5.6%
e. 5.8%

12. If D0 = \$2.00, g (which is constant) = 6%, and P0 = \$40, what is the stock's expected total return for the coming year?

a. 9.8%
b. 10.3%
c. 10.8%
d. 11.3%
e. 11.8%

13. The Lashgari Company is expected to pay a dividend of \$1 per share at the end of the year, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price?

a. \$15.00
b. \$20.00
c. \$25.00
d. \$30.00
e. \$35.00

14. The Corrigan Company just paid a dividend of \$1 per share, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price?

a. \$19.25
b. \$21.00
c. \$22.75
d. \$24.50
e. \$26.25

15. You must estimate the intrinsic value of Gallovits Technologies' stock. Gallovits's end-of-year free cash flow (FCF) is expected to be \$25 million, and it is expected to grow at a constant rate of 8.5% a year thereafter. The company's WACC is 11%. Gallovits has \$200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Gallovits' estimated intrinsic value per share of common stock?

a. \$22.67
b. \$24.00
c. \$25.33
d. \$26.67
e. \$28.00

16. Stock A has a required return of 10% and a price of \$25, and its dividend is expected to grow at a constant rate of 7% per year. Stock B has a required return of 12% and a price of \$40, and its dividend is expected to grow at a constant rate of 9% per year. Which of the following statements is CORRECT?

a. The two stocks have the same dividend yield.
b. If the stock market were efficient, these two stocks would have the same price.
c. If the stock market were efficient, these two stocks would have the same expected return.
d. The two stocks have the same expected capital gains yield.
e. The two stocks have the same expected year-end dividend.

17. Assume that you are a consultant to Thornton Inc., and you have been provided with the following data: rRF = 5.5%; RPM = 6.0%; and b = 0.8. What is the cost of equity from retained earnings based on the CAPM approach?

a. 9.65%
b. 9.91%
c. 10.08%
d. 10.30%
e. 10.49%

18. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 = \$1.00; P0 = \$25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the DCF approach?

a. 9.79%
b. 9.86%
c. 10.00%
d. 10.20%
e. 10.33%

19. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm's WACC?

a. 8.25%
b. 8.38%
c. 8.49%
d. 8.61%

20. Reingaart Systems is expected to pay a \$3.00 dividend at year end (D1 = \$3.00), the dividend is expected to grow at a constant rate of 7% a year, and the common stock currently sells for \$60 a share. The before-tax cost of debt is 8%, and the tax rate is 40%. The target capital structure consists of 60% debt and 40% common equity. What is the company's WACC if all equity is from retained earnings?

a. 7.17%
b. 7.31%
c. 7.45%
d. 7.68%
e. 7.84%

21. Blanchford Enterprises considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.

WACC = 10%
Year: 0 1 2 3 4
Cash flows: -\$1,000 \$475 \$475 \$475 \$475

a. \$482.16
b. \$496.38
c. \$505.69
d. \$519.05
e. \$524.72

22. Tapley Dental Associates is considering a project that has the following cash flow data. What is the project's payback?

Year: 0 1 2 3 4 5
Cash flows: -\$1,000 \$300 \$310 \$320 \$330 \$340

a. 2.11 years
b. 2.50 years
c. 2.71 years
d. 3.05 years
e. 3.21 years

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