Question

1. A corporate bond has a 12 percent coupon, pays interest semiannually, and matures in 10 years at $1,000. If the investor's required rate of return is 14 percent, what should the current market price of the bonds be? 2. North Pole Air has an issue of preferred stock outstanding that pays dividends of $8.50 annually. The par value of each preferred share is $100. Investors require a 12.25 percent rate of return on this stock. The next annual dividend is due tomorrow. What should the current market price be? [Hint: This problem has a little twist!]. 3. Johnsway common stock has a 6 percent expected growth rate in dividends, and this growth rate is expected to remain constant for the foreseeable future. Very recently, Johnsway paid an annual dividend of $4.25 per share. If you require a 15 percent return on stock of this risk class, what is the maximum price you would be willing to pay for this stock? 4. An Earl Enterprises bond has an 8 percent coupon, pays interest semiannually, and matures in six years at $1,000. If the current market price is $911.33, what is the yield to maturity for this bond? 5. If Earl Enterprises (from problem 4) is currently planning to issue new bonds in the primary market, what will be the coupon rate they will have to offer potential investors if the bonds are going to sell at their face value? 6. Investors expect Swift Company's dividends to grow 20 percent per year for the next 2 years, 15 percent during the third year, and 7 percent per year thereafter. Swift's most recent dividend was $2 per share. The investors' required rate of return is 10 percent. What is the current market price of Swift's stock?

Answer 1

1) Bond Price can be calculated using PV function on a calculator

N = 10 x 2 = 20, PMT = 12% x 1000 / 2 = 60, FV = 1000, I/Y = 14%/2 = 7%

=> Compute PV = $894.06

2) Price tomorrow = Dividend / Rate = 8.50 / 12.25% = $69.39

Price today = 69.39 / (1 + 12.25%)^(1/365) = $69.37

3) Price = D0 x (1 + g) / (r - g) = 4.25 x (1 + 6%) / (15% - 6%) = $50.06

4) YTM can be calculated using I/Y function

N = 6 x 2 = 12, PV = -911.33, FV = 1000, PMT = 8% x 1000 / 2 = 40

=> Compute I/Y = 5.00% (semi-annual)

YTM = 5% x 2 = 10.00%

5) Coupon rate = YTM = 10%