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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 matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment was made yesterday. a) If the yield to maturity for all three bonds is 8%, what is the fair price of each bond? b) Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of each bond now? c) Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what is the fair price of each bond? d) Base on the fair process at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer-versus shorter-maturity bonds?
B18. (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principle in 10 years. You pay only $500 for the bond. a) You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment? b) The firm does far better than expected and bondholders receive all of the promised interest and principal payments. What is the realized return on your investement?
B20. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and that the divends will increase 6% annually thereafter. Bret Kimes, one of James’ colleagues at the same firm, is less optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividends will be $1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.
Chapter 7 Problem C1 CI. (Beta and require return) The riskless return is currently 6%, AND Chicago Gear has estimated the contingent returns given here. a. Calculate the expected return on the stock market and on Chicago Gear stock. b. What is Chicago Gear’s beta? c. What is Chicago Gear’s required return according to the CAPM? REALIZED RETURN State of the Market Probability that Sate Occurs Stock Market Chicago Gear Stagnant 0.20 (10%) (15%) Slow growth 0.35 10 15 Average growth 0.30 15 25 Rapid growth 0.15 25 35
