Gwen Moore

July 26, 2014

BAD-312 CASE STUDY PROJECT - PART A
Chapter 7 Integrated Case (#7-21), page 254
d. A bond's value is determined by the present value of the cash flows the asset is expected to produce.
Example: V
B
= INT + INT +. . . + INT + M
(1 + r
d
)
1
(1 + r
d
)
2
1 + r
d
)N (1 + r
d
)N
= N INT + M
t = 1 (1+ r
d
)
t
(1 + r
d
)
N

N = 10 X 2= 20; YTM/2 = 10%/2 = 5%; 10% X $1000 = 100
Calculator: N = 20; I/YR = 5; PMT = 100; FV = 1,000 CPT PV. PV should be -1,623.11.

e. 1) 13% x $1000 = 130
Calculator: N = 20; I/YR = 5; PMT = 130; FV = 1,000 CPT PV. PV should be -1996.98 which is a Premium bond.
2) 7% X $1000 = 70
Calculator: N = 20; I/YR = 5; PMT = 70; FV = 1,000 CPT PV. PV should be -1,249.24 which is a Discount bond.
3) Calculator: PMT= 70= PV= 350; 100= PV= 500; & 130= PV= 650; (PMT; I/YR = 5; FV = 1000; N = 20; 20 +/-
PV; CPT I/YR.) The PV is no longer negative but increases in value over time.

f. 1) $90/$887.00 = 10.15%; $90/$1,134.20 = 7.94%. A higher sell price causes a lower YTM rate.
2) Current yield = Annual coupon payment/Price = $90/$1,134.20 = 7.94%; Capital gains yield = Total yield
Current yield = 10.15% - 7.94% = 2.21%; Total return = YTM = 10.15%.

g. Price risk is when interest rates fluctuate over time and when they rise, the value of outstanding bonds
decline. This risk decline of a decline in bond values due to an increase in interest rates is called price risk (or
interest rate risk). Price risk is higher on bonds that have long maturities than on bonds that will mature in the
near future. This follows because the longer the maturity, the longer before the bond will be paid off and the
bondholder can replace it with another bond with a higher coupon.

h. Reinvestment risk is the risk that a decline in interest rates will lead to a decline in income from a bond
portfolio. It is higher on short-term bonds because the shorter the bonds maturity, the fewer the years before
the relatively high-old coupon bonds will be replaced with the new low-coupon issues.

i. 1) Divide the annual coupon interest payment by 2 to determine the dollars of interest paid each six month.
2) Multiply the years to maturity, N, by 2 to determine the number of semiannual periods.
3) Divide the nominal (quoted) interest rate, r
d,
by 2 to determine the periodic (semiannual) interest rate.
On a time line, there would be twice as many payments, but each would be half as large as with an annual
payment bond. N =20; I/YR =5; PMT=130; FV= 1000; PV = -1,996.98.

j. Im not sure which one I would prefer since they are both equally risky. When a stocks actual market price is
equal to its intrinsic value, the stock is in equilibrium. The equilibrium price for the annual payment bond is
equal to the proper price of the semiannual bond of $1,000.
k. 1) The bonds nominal yield to call (YTC) = N= 4; PV= -1,050; PMT=100; FV=1,000; I/YR= 8.47%
2) Yield to call (YTC), because if current interest rates are well below an outstanding bonds coupon rate, a
callable bond is likely to be called; and investors will estimate its most likely rate of return as the yield to call
(YTC) rather than the yield to maturity (YTM).
Chapter 8 Integrated Case (#8-23), page 295 - 296
b. Expected rate of return= Row r=Probability = 0.2; T-bills = 5.5%; High Tech = 12.4; and 2-Stock Portfolio =
6.2.
i. 1) Required return on Stock L = Risk-free return = 5.5% + 5.5% x 5.5% = 5500 + (Market risk premium)(Stock
Ls beta). 5.5% + 5.5% x 5.5%= 8.03%
2) If the rate of return is greater than the expected rate of return, the investor will purchase the stock
because it looks like a bargain. Buying and selling by investors tends to force the expected return to equal the
required return, although the two can differ from time to time before the adjustment is completed.
3) Yes, I think this is the impact of expected inflation. The real rate on long-term Treasury bonds has
historically ranged from 2% to 4%, with a mean of about 3%. Therefore, if no inflation were expected, long-
term Treasury bond would be about 3%. However, as the expected rate of return inflation increases, a
premium must be added to the real risk-free rate of return to compensate investors for the loss of purchasing
power that results from inflation.
4) High Tech 5.5% + 12.4 X 1.32 = 21.87% Collections -5.5% + 1.0 X (0.87) = -8.05%; High Tech 5.5% = 12.4
X 9.8 = 17.54%; U.S. Rubber 5.5% + 9.8 X 0.88 = 13.46%
Chapter 9 Integrated Case (#9-23), page 328
c. Required rate of return = 7% + 12% X 1.2 = 21.4%
d. 1) D
1
= D
0
(1+g)= $2.00 X (1+6%) = 2.12 x (3 years X 2 semiannual payments) = 12.72%
2) $2.12
3) $2.12 x 2 semiannual payments per year = $4.24
4) 5%, 6%, & 11%
e. $30.29 + $2.00 X (1+11%) = $32.51

f. $2.00 x 3 years x 2 semiannual payments = $12.00
g. 30% X 3 years = 9% - 6% = 3%; 30% X 3 years X 2 semiannual periods = 1.8%; Year 1? 30% x 1 year X 2
semiannual periods = 6%; Year 4? 6% X 4 x2 = 48%
h. 6%X 3 years = 9%; Year 1? 6%; Year 4? 6% X 4 = 24%