Week 2 Text Problem Set
Candy Wungnema
FIN/571
February 5, 2013
Kathleen O’Keefe
Week 2 Text Problem Set
Chapter 5
4. Define the following terms: bond indenture, par value, principal, maturity, call provision, and sinking fund.

• Bond indenture: A contract for a bond defining specified terms for interest and borrowed capital to be repaid to the lender. • Par value: “Specifies the amount of money that must be repaid at the end of the bond’s life, which is also called face value or maturity value” (Emery, Finnerty, & Stowe, 2007, p. 112). • Principal: The original amount of debt or balance borrowed, which does not include interest. • Maturity: The life end of a contractual obligation.

• Call provision: The right for the issuer to payoff bonds prior to the maturity date (Emery, Finnerty, & Stowe, 2007). • Sinking funds: Bon repayment in multiple installments (Emery, Finnerty, & Stowe, 2007).

11. What is interest-rate risk? How is interest-rate risk related to the maturity of a bond and to the coupon rate for a bond?

“Interest-rate risk is the sensitivity of a bond’s value to interest-rate change as it depends primarily on the bond’s remaining maturity” (Emery, Finnerty, & Stowe, 2007, p. 132). An issued bond pays a fixed rate of interest called a coupon rate until it matures. The current prevailing interest rates and the perceived risk of the issuer are related to the rate. Upon a bond sale on the secondary market prior to the maturity date will affect the value of the bond and not the coupon as the rates are based on the market interest rates as the time of sale.

A6. (Yield to maturity) Marstel Industries has a 9.2% bond maturing in 15 years. What is the yield to maturity if the current market price of the bond is: a. $1,120? b. $1,000? c. $785? a. Current Price $1,120

...FIN 571 Week 2 Individual Study Guide: TextProblemSets
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FIN 571 Week Two
Individual Assignment: TextProblemSets
Top of Form
Bottom of Form
CHAPTER 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is non-growing. What is the required return on James River preferred stock?
B16. (Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose PhilEl’s bonds have identical coupon rates of 9.125% but that one issue...

...FIN/571: Corporate Finance
TextProblemSets - Week Two
Chapter Five
Question # 4
Define the following terms: bond indenture, par value, principal, maturity, call provision, and sinking fund.
Bond indenture. Bond indenture is a legal contract for a publicly traded bond. The structure of this contract outline incentives explicitly by detailing responsibilities, constraints, penalties, and oversight required. For example, contracts may specify interest and principal payment timing and amounts.
Par value. Par value denotes face value or designated value of a bond or stock. Par value of a bond is typically $1,000 and the sum investors pay upon issue. It is also the sum received when they redeem the bond matures. Conversely, stock par value is frequently set at $1. In this case, par value is an accounting tool that shows no connection to the stocks’ market value.
Principal. The term “principal” refers to a sum of money one borrows or invests. The face amount of a bond - the value printed on a stock or bond, or a debt balance. Principal does not encompass finance charges. Principal also describes an investor represented by a broker who executes trades on that investor’s behalf or an investor who trades for his or her own benefit. Principal also refers to a party affected by an agent’s decisions in a principal-agent relationship.
Maturity. Maturity is the end of a bond’s life. In finance, maturity (or...

...Chapter 8
Supplemental Homework/Practice Problems
Solutions may be found on the FIN 380 site of i-Tunes U near the bottom of the file list under "Supplemental Homework - Chapter 8"
8-1. AEH, Inc. just paid a $1.00 dividend and is expected to pay a $1.06 dividend next year. What is AEH’s capital gains yield (growth rate, “g”)?
8-2. XYZ, Inc. stock sells for $50.00 and is expected to sell for $54.50 next year. What is XYZ’s capital gains yield (Hint: the percentage change in stock price is the same as the growth rate, “g”)?
8-3. PDQ, Inc. stock current sells for $15.00 per share. The company is expected to pay a $1.50 dividend and sell for $17.25 one year from now.
a. What is PDQ’s dividend yield?
b. What is PDQ’s capital gains yield?
c. What is PDQ’s total expected rate of return?
8-4. AMB, Inc.’s common stock is expected to pay a $2.60 dividend in the coming year. If investors require a 14% return and the growth rate in dividends is expected to be 9%, what is the price of common stock?
8-5 A share of preferred stock pays a $2 annual dividend. It is priced at $40 per share. What is the required rate of return on the preferred stock?
8-6 What is the price of preferred stock paying a $4 annual dividend if investors require a 14% rate of return on the stock?
Chapter 14
Supplemental Homework/Practice Problems
Solutions may be found on the FIN 380...

...FIN 350
Prof. Porter
ProblemSet 4
1. Describe what happens to the total risk of a portfolio as the number of securities is increased. Differentiate between systematic risk and unsystematic risk and explain how total risk and systematic risk are measured.
As the number of securities increases, the total risk of the portfolio decreases. This decrease occurs due to the benefits of diversification which is the process of acquiring a portfolio of securities that have dissimilar risk-return characteristics in order to reduce overall portfolio risk. The total risk of a security or a portfolio is measured with the variance or standard deviations of returns (std dev. ^2 = variance). The larger the standard deviation, the greater the total risk and the more likely it is that you will have a large price move.
Unsystematic risk is the unique or security specific risks that tend to partially offset one another in a portfolio. /this could happen when the price of one stock in the portfolio goes down, the price of another tends to go up, which partially offsets the loss. As long as the returns of two securities are not perfectly, positively correlated, one can reduce total risk by combining securities in a portfolio. By adding securities to a portfolio, it is possible to eliminate unsystematic risk.
Systematic risk is also known as market risk or nondiversifiable risk. The risk tends to affect the entire market...

...ProblemSets
Chapter 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
Calculating PV factor:
i= required return = 9% = 0.09
n= 10 years
Using Cash Flow of $1000 to calculate present value,
Cash flow= $1000
PV factor = 1/(1+i)^n = 0.42241
PV = $1000*0.42241= 422.41
Using Coupon Rate to calculate present value of Annuity
Cash flow= $1000 * 7.4/100 = $74
PV factor = (1/i)*(1- 1/(1+i)^n) = 6.4176
So, PV = $74*6.4176 = 474.90|
So the fair value of bond = 474.90+422.41 = $897.31
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
Current market value = D1/(Required return – growth rate)
= 5.60/(10%-6%) = $140
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividends is now growing. What is the required return on James River preferred stock?
Required Return = Dividend/Market Price
Dividend = $3.38
Market Price = $45.25
Required Return = $3.38 / $45.25
Required Return = 7.47%
A14.(Stock Valuation) Suppose Toyota has nonmaturing...

...A-3 (Coverage ratio) The firm in the two preceding problems also had $6 million of principal repayments during the latest 12 months. Its marginal tax rate is 40%. Calculate the debt service coverage ratio.
Debt-Service Coverage Ratio = (EBIT + 1/3 Rentals) / (Interest Expense + 1/3 Rentals + Principal Repayments / (1 - T)) = ($30 + $15 / 3) / ($10 + $15 / 3 + $6 / (1 - 0.40)) = 1.40
A-4 (WACC with rebalancing) Nathan’s Catering is a gourmet catering service located in Southampton, New York. It has an unleveraged required return of r = 43%. Nathan’s rebalances its capital structure each year to a target of L = 0.52. T* = 0.20. Nathan’s can borrow currently at a rate of r
of r = 43%. Nathan’s rebalances its capital structure each year to a target of L = 0.52. T* = 0.20. Nathan’s can borrow currently at a rate of rd = 26%. What is Nathan’s WACC?
WACC = r - T* L rd [(1 + r) / (1 + rd)]
WACC = 0.43 - 0.20 x 0.52 x 0.26 [(1 + 0.43) / (1 + 0.26)] = 0.3993 = 39.93%
A-10 (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend...

...TextProblemSets
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a
required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
Number of years (N) = 10, future value (FV) = 1000, interest rate (I/YR) = 9
0.074 * 1000 = 74 = PMT or annual payment, I then pressed CPT on my financial calculator to compute the price of the bond and then pressed PV or present value.
The fair value of the bond is $897.32.
Using Cash Flow of $1000 to calculate present value,
Cash flow= $1000
PV factor = 1/(1+i)^n = 0.42241
PV = $1000*0.42241= 422.41
Using coupon rate to calculate present value of annuity
Cash flow= $1000 * 7.4/100 = $74
PV factor = (1/i)*(1- 1/(1+i)^n) = 6.4176
So, PV = $74*6.4176 = 474.90|
So the fair value of bond = 474.90+422.41 = $897.31
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60
next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming
annual dividend payments, what is the current market value of a share of RHM stock if the
required return on RHM common stock is 10%?
Current market value = D1/(Required return – growth rate) = 5.60/(10%-6%) = $140
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividends is now growing. What is the required return on James River preferred stock?
Required...

...Sauder School of Business
Finance Division
COMM 371 Sep-Dec 2011
Gonzalo Morales
Marked ProblemSet2 - Solution Notes
1. First, compute the correlation coeﬃcient between assets A and B
ρ(RA , RB ) =
Cov (RA , RB )
−0.0322
=
= −1.
σ (RA )σ (RB )
0.14 × 0.23
The assets are perfectly negatively correlated. Consider portfolio P formed from assets
A and B such that you invest α fraction of your wealth into A and (1 − α) fraction
into B. The variance of such portfolio is
σ (RP )2 =
=
=
=
α2 σ (RA )2 + (1 − α)2 σ (RB )2 + 2α(1 − α)Cov (RA , RB )
α2 σ (RA )2 + (1 − α)2 σ (RB )2 + 2α(1 − α)σ (RA )σ (RB )ρ(RA , RB )
α2 σ (RA )2 + (1 − α)2 σ (RB )2 − 2α(1 − α)σ (RA )σ (RB )
[ασ (RA ) − (1 − α)σ (RB )]2 .
Therefore, the standard deviation of portfolio P is
σ (RP ) = ασ (RA ) − (1 − α)σ (RB ).
As assets A and B are perfectly negatively correlated, we can construct portfolio P
such that its standard deviation is 0. The weights of such portfolio are
0 = ασ (RA ) − (1 − α)σ (RB )
= 0.14 × α − 0.23 × (1 − α).
Solving the above equation for α gives
α=
0.23
= 0.622.
0.14 + 0.23
Portfolio P with standard deviation zero has weight 0.622 on asset A and weight 0.378
on asset B. The expected return of this portfolio (equal to the actual return as the...

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