# Finance questions

Question 29. Suppose the term structure of risk-free interest rates is as shown below:

 1 year 2 years 3 years 5 years 7 years 10 years 20 years Rate (EAR, %) 1.99 2.41 2.74 3.32 3.76 4.13 4.93

a.Â Calculate the present value of an investment that pays \$1000 in two years and \$2000 in five years for certain.
b.Â Calculate the present value of receiving \$500 per year, with certainty, at the end of the next five years. To find the rates for the missing years in the table, linearly interpolate between the years for which you do know the rates. (For example, the rate in year 4 would be the average of the rate in year 3 and year 5.)

c.Â Calculate the present value of receiving \$2300 per year, with certainty, for the next 20 years. Infer rates for the missing years using linear interpolation. (Hint: Use a spreadsheet.)

Question 31: What is the shape of the yield curve given the term structure in Problem 29? What expectations are investors likely to have about future interest rates?

Question 2:Â Assume that a bond will make payments every six months as shown on the following timeline (using six-month periods):

a.Â What is the maturity of the bond (in years)?

b.Â What is the coupon rate (in percent)?

c.Â What is the face value?

Question 6:Â Suppose a 10-year, \$1000 bond with an 8% coupon rate and semiannual coupons is trading for a price of \$1034.74.

a.Â What is the bondâ€™s yield to maturity (expressed as an APR with semiannual compounding)?

b.Â If the bondâ€™s yield to maturity changes to 9% APR, what will the bondâ€™s price be?

Question 7.Â Suppose a five-year, \$1000 bond with annual coupons has a price of \$900 and a yield to maturity of 6%. What is the bondâ€™s coupon rate?

Question 10.Â Suppose a seven-year, \$1000 bond with an 8% coupon rate and semiannual coupons is trading with a yield to maturity of 6.75%.

a.Â Is this bond currently trading at a discount, at par, or at a premium? Explain.

b.Â If the yield to maturity of the bond rises to 7% (APR with semiannual compounding), what price will the bond trade for?

Question28.Â The following table summarizes the yields to maturity on several one-year, zero-coupon securities:

 Security Yield (%) Treasury 3.1 AAA corporate 3.2 BBB corporate 4.2 B corporate 4.9

a.Â What is the price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating?

b.Â What is the credit spread on AAA-rated corporate bonds?

c.Â What is the credit spread on B-rated corporate bonds?

d.Â How does the credit spread change with the bond rating? Why?

Question 30. HMK Enterprises would like to raise \$10 million to invest in capital expenditures. The company plans to issue five-year bonds with a face value of \$1000 and a coupon rate of 6.5% (annual payments). The following table summarizes the yield to maturity for five-year (annual-pay) coupon corporate bonds of various ratings:

 Rating AAA AA A BBB BB YTM 6.20% 6.30% 6.50% 6.90% 7.50%

a.Â Assuming the bonds will be rated AA, what will the price of the bonds be?

b.Â How much total principal amount of these bonds must HMK issue to raise \$10 million today, assuming the bonds are AA rated? (Because HMK cannot issue a fraction of a bond, assume that all fractions are rounded to the nearest whole number.)

c.Â What must the rating of the bonds be for them to sell at par?

d.Â Suppose that when the bonds are issued, the price of each bond is \$959.54. What is the likely rating of the bonds? Are they junk bonds?

Question 1. The figure below shows the one-year return distribution for RCS stock.

Calculate:

a.Â The expected return.

b.Â The standard deviation of the return.

Question 30.Â What does the beta of a stock measure?

Question 35.Â Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 10.6, calculate the expected return of investing in

TABLE 10.6 Betas with Respect to the S&P 500 for Individual Stocks (based on monthly data for 2007â€“2012)

 Company Ticker Industry Equity Beta General Mills GIS Packaged Foods 0.20 Consolidated Edison ED Utilities 0.28 The Hershey Company HSY Packaged Foods 0.28 Abbott Laboratories ABT Pharmaceuticals 0.31 Newmont Mining NEM Gold 0.32 Wal-Mart Stores WMT Superstores 0.35 Clorox CLX Household Products 0.39 Kroger KR Food Retail 0.42 Altria Group MO Tobacco 0.43 Amgen AMGN Biotechnology 0.44 McDonaldâ€™s MCD Procter & Gamble PG Household Products 0.47 Pepsico PEP Soft Drinks 0.51 Coca-Cola KO Soft Drinks 0.54 Johnson & Johnson JNJ Pharmaceuticals 0.59 PetSmart PETM Specialty Stores 0.75 Molson Coors Brewing TAP Brewers 0.78 Nike NKE Footwear 0.91 Microsoft MSFT Systems Software 1.01 Southwest Airlines LUV Airlines 1.09 Intel INTC Semiconductors 1.09 Whole Foods Market WFM Food Retail 1.10 Foot Locker FL Apparel Retail 1.11 Oracle ORCL Systems Software 1.12 Amazon.com AMZN Internet Retail 1.13 Google GOOG Internet Software and Services 1.14 Starbucks SBUX Restaurants 1.20 Walt Disney DIS Movies and Entertainment 1.21 Cisco Systems CSCO Communications Equipment 1.23 Apple AAPL Computer Hardware 1.26 PulteGroup PHM Homebuilding 1.28 Dell DELL Computer Hardware 1.41 salesforce.com CRM Application Software 1.47 Marriott International MAR Hotels and Resorts 1.48 eBay EBAY Internet Software and Services 1.48 Coach COH Apparel and Luxury Goods 1.60 Macyâ€™s M Juniper Networks JNPR Communications Equipment 1.71 Williams-Sonoma WSM Home Furnishing Retail 1.72 Tiffany & Co. TIF Apparel and Luxury Goods 1.80 Caterpillar CAT Construction Machinery 1.85 Ethan Allen Interiors ETH Home Furnishings 1.95 Autodesk ADSK Application Software 2.14 Harley-Davidson HOG Motorcycle Manufacturers 2.23 Advanced Micro Devices AMD Semiconductors 2.24 Ford Motor F Automobile Manufacturers 2.38 Sothebyâ€™s BID Auction Services 2.39 Wynn Resorts Ltd. WYNN Casinos and Gaming 2.41 United States Steel X Steel 2.52 Saks SKS Department Stores 2.57

Source:Â CapitalIQ

a.Â Starbucksâ€™ stock.

b.Â Hersheyâ€™s stock.

c.Â Autodeskâ€™s stock.

Question 37.Â Suppose the market risk premium is 6.5% and the risk-free interest rate is 5%. Calculate the cost of capital of investing in a project with a beta of 1.2.

Question 2.Â You own three stocks: 600 shares of Apple Computer, 10,000 shares of Cisco Systems, and 5000 shares of Colgate-Palmolive. The current share prices and expected returns of Apple, Cisco, and Colgate-Palmolive are, respectively, \$500, \$20, \$100 and 12%, 10%, 8%.

a.Â What are the portfolio weights of the three stocks in your portfolio?

b.Â What is the expected return of your portfolio?

c.Â Suppose the price of Apple stock goes up by \$25, Cisco rises by \$5, and Colgate-Palmolive falls by \$13. What are the new portfolio weights?

d.Â Assuming the stocksâ€™ expected returns remain the same, what is the expected return of the portfolio at the new prices?

## Finance questions

QUESTIONS :
1 . Three \$1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
a. Bond A’s current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected to stay the same, and Bond C’s price is expected to increase.
2. Which of the following statements is CORRECT?
a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
3. Which of the following statements is CORRECT?
a. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.
b. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.
c. If a bond sells at par, then its current yield will be less than its yield to maturity.
d. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.
e. A discount bond’s price declines each year until it matures, when its value equals its par value.
4. Suppose a new company decides to raise a total of \$200 million, with \$100 million as common equity and \$100 million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original \$100 million. Given these conditions, which of the following statements is CORRECT?
a. The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm’s total dollar interest charges will be.
b. If the debt were raised by issuing \$50 million of debentures and \$50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing \$100 million of debentures.
c. In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense on the \$100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm’s total interest charges would not be affected materially by the mix between the two.
d. The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.
e. If the debt were raised by issuing \$50 million of debentures and \$50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing \$100 million of first mortgage bonds.
5. Cosmic Communications Inc. is planning two new issues of 25-year bonds. Bond Par will be sold at its \$1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a \$1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Cosmic issue to raise \$3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.
a. 4,228
b. 4,337
c. 4,448
d. 4,562
e. 4,676

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