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FIN 571

Text Problem Sets and Concept and Principles Summary

Problem A3: (Bond valuation) General Electric made a coupon payment yesterday on its 6.75% bonds that mature in 8.5 years. If the required return on these bonds is 8% APR, what should be the market price of these bonds? PMT -33.75

FV -1000

N 17

Rate 4%

Market Price $923.96

Fair Value of a bond = C/r*(1-1/(1+r)^n)+M/(1+r)^n

Assuming that it’s a semi-annual bond with face value of $1000

A13. (Required return for a preferred stock) Sony $4.50 preferred is selling for $65.50. The preferred dividend is non-growing. What is the required return on Sony preferred stock?

PV Perpetuity = D / r r = D / PV r = $4.50 / $65.50 = 6.87%

A15. (Stock valuation) Let’s say the Mill Due Corporation is expected to pay a dividend of $5.00 per year on its common stock forever into the future. It has no growth prospects whatsoever. If the required return on Mill Due’s common stock is 14%, what is a share worth? Share Price = Dividend/Required Return

P0 = D1 / (r - g)

P0 = $5.00 / (0.14 - 0.00) = $35.71

B15.

(Interest-rate risk) A quick look at bond quotes will tell you that GMAC has many different issues of bonds outstanding. Suppose that four of them have identical coupon rates of 7.25% but mature on four different dates. One matures in 2 years, one in 5 years, one in 10 years, and the last in 20 years. Assume that they all made coupon payments yesterday.

If the yield curve were flat and all four bonds had the same yield to maturity of 9%, what would be the fair price of each bond today?

Suppose that during the first hour of operation of the capital markets today, the term structure shifts and the yield to maturity of…...

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