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Module 2-practice problems

01 Problem New price =806.96

Consider a bond with: $1000 face value, semiannual % change = -14.61%
coupon payments @5% per annum , time to maturity
=5 years. Its yield to maturity is 6.3% . Suppose Sensitivity = -3.947
because of decreasing liquidity in the system the
govt. increases all interest rates because of which the
yield to maturity of the bond increased to 10%( from
6.3%)

What is the % change in the bond’s price?

What is the sensitivity of the price change w.r.t

change in YTM ?

02 Consider a five-year, $1000 bond with 5% coupon 3%,2%

rate and semiannual coupons with 10% YTM. Find
the CGY and the CuY of the bond at the end of 1
period (i.e one semiannual period) ? At the end of 2
periods?

03 You are given two bonds identical in every way 1064.92

except for their coupons and of course their prices.
The first bond has a 10% coupon rate and sells for
$935.08. The second has a 12% coupon rate. The
maturity period for the bonds is 12 yrs. What do you
think it would sell for?

04 The Sue Fleming Corporation has two different 18,033.86

bonds currently outstanding. Bond A has a face value
of $40,000 and matures in 20 years. The bond makes 3888.89
no payments for the first six years and then pays
$2,000 semiannually for the subsequent eight years,
and finally pays $2,500 semiannually for the last six
years. Bond B also has a face value of $40,000and a
maturity of 20 years; it makes no coupon payments
over the life of the bond. If the required rate of return
is 12 percent compounded semiannually, what is the
current price of Bond A? of Bond B?

05 Six years ago, the Singleton company issued 20-year • 14.98% APR.
bonds at par with a 14% annual coupon rate on their
$1000 par value. The bonds had a 9% call premium,
with 6 years of call protection. Today (at the end of 6 =RATE(12,-70,1000,-1090,0,0.1)
years) Singleton called the bonds. Compute the
realized rate of return for an investor who purchased

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the bonds when they were issued and held them when
they were called. Assume semiannual coupon
payment.

06 Bond X is noncallable and has 20 years to maturity, a • $987.87

9% annual coupon, and a $1000 par value. Your
required return on Bond X is 10%; and if you buy it,
you plan to hold it for 5 years. You (and the market)
have expectations that in 5 years, the yield to
maturity on a 15-year bond with similar risk will be
8.5%. How much should you be willing to pay for
the bond X today? (Hint : You will need to know
how much the bond will be worth at the end of 5
years )

07 You are considering a 10-year, $1000 par value • $1,067.95

bond. Its coupon rate is 9% and interest is paid
semiannually. If you require an effective annual
interest rate (not a nominal rate) of 8.16%, how much
should you be willing to pay for the bond?

08 The YTM on a bond is the interest rate you earn on 9.43%

your investment if the interest rates don’t change. If
you actually sell the bond before it matures, your
realized return is known as the Holding Period Yield
(HPY)

Suppose that today you buy an 8 percent annual

coupon bond for $ 1,105. The bond has 10 years to
maturity. What rate of return do you expect to earn
on your investment?

Two years from now, the YTM on your bond has

declined by 1 percent, and you decide to sell. What
will your bond sell for? What is the HPY on your
investment?

09 Bond P is a premium bond with 9% coupon. Bond D P: Current yield= 8.32%, Capital
is a 5 percent coupon bond currently selling at a gains yield = –1.32%
discount. Both bonds make annual payments, have a
YTM of 7 percent, and have 5 years to maturity. D: Current yield =5.44%,
What is the current yield of bond P? For bond D? If Capital gains yield = +1.55%
interest rate remains unchanged what is the expected
capital gains yield over the next year for bond P? For
bond D? Explain your answers and the inter
relationships among the various types of yields.

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10 The St Anger Corporation needs to raise $25 million Ans : 776,398

to finance its expansion into new markets. The
company will sell new shares of equity via a general
cash offering to raise the needed funds. If the offer
price is $35 per share and the company’s
underwriters charge an 8% spread, how many shares
need to be sold?

11 A firm is thinking of raising Rs. 5 crore . It has 5 • 400,000, 1.25 , Rs. 150,
lakh shares outstanding and the current market price R= 20
of a share is Rs. 170.The subscription price of the
new share will be Rs. 125 per share.

− How many shares would be sold?

− How many rights are needed to
purchase one new share ?
− What is the value of one right?
− Show the impact on a shareholder’s
wealth who holds required rights to
buy one new share if a) he exercises
rights b) sells his rights and c) does
not exercise rights

12 XYZ co has announced a rights offer. The company No

has announced that it will take four rights to buy a
new share in the offering at a subscription price of
$40.At the close of business the day before the ex
rights day, the company’s stock sells for $80 per
share. The next morning it is noticed that the stock
sells for $72 per share and the rights sell for $6 each.
Are the stocks and the rights correctly priced on the
ex rights day? If not, then describe a transaction in
which you could use these prices to create an
immediate profit.

13 Atlas Corporation wants to raise $4.1 million via a 3964.88

rights offering. The company currently has 490,000
shares of common stock outstanding that sell for $40
per share. Its underwriter has set a subscription price
of $36 per share and will charge the company a 4%
spread. Over and above that the other components of
floatation costs amount to another 2% of the
subscription price. If you currently own 5000 shares
of stock in the company and decide not to participate
in the rights offering, how much money can you get
by selling your rights?

14 A company’s dividend is expected to grow @20% 66.64

for the next five years. After that, the growth rate is

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expected to be 4% forever. If the required return is

10%, what is the value of the stock. The dividend just
paid was $2.

15 Great Pumpkin farms just paid a dividend of $3.50 $50.75

on its stock. The growth rate in dividends is expected
to be a constant 5% per year indefinitely. Investors
require a 16% return on the stock for the first 3 years,
a 14% return on the stock for the next 3 years and an
11% return thereafter. What should be the current
share price?

16 Metallica Bearings Inc. is a young startup company. $47.55

No dividends will be paid on the stock over the next
nine years because the firm needs to plough back its
earnings to fuel growth. The company will pay a $10
per share dividend in year 10 and will increase the
dividend by 6% per year thereafter. If the required
return on the stock is 13%, what is the current share
price?

17 Spears Inc. has an odd dividend policy. The company $51.13

has just paid a dividend of $7 per share and
announced that it will increase the dividend by $4 per
share for each of the next four years, and then never
pay another dividend. If you require an 11% return
on the company’s stock, how much will you pay for a
share today? What do you think should be price of
the share four years after?

18 Consider a stock Z which have a required rate of Z: Div yield =5.6%, Cap Gains
return of 18% and a most recent dividend of $4.50 yield=12.4%
per share. Stock Z is a growth stock that will increase
its dividend by 20% for the next two years and then
maintain a constant 12% growth rate thereafter. What
is the dividend yield for the stock? What is the
expected capital gains yield?

19 Storico Co. just paid a dividend of $2.75 per share. P0 = $46.76

The company will increase its dividend by 20% next
year and will then reduce its dividend growth rate by
5% per year until it reaches the industry average of
5% dividend growth, after which the company will
keep a constant growth rate forever. If the required
rate on Storico stock is 13%, what will a share sell
for today?

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20 North Great Timber company will pay a dividend of

$1.50 a share next year. After this, earnings and
dividends are expected to grow at a 9% annual rate
indefinitely. Investors currently require a rate of
return of 13%. The company is considering several
business strategies and wishes to determine the effect
of these strategies on the market price per share of its
stock.

A. Continuing the present strategy will result in the

expected growth rate and required rate of return
stated above.

B. Expanding timber holdings and sales will increase

the expected dividend growth rate to 11% but will
increase the risk of the company. As a result, the rate
of return required by the investors will increase to
16%.

C. Integrating into retail stores will increase the

dividend growth rate to 10% and increase the
required rate of return to 14%.

What should be the best strategy for the company’s

management?

21 Taussig Technologies Corporation (TTC) has been 7.47%

growing at a rate of 20% per year in recent years.
The same growth rate is expected to last for another 2
years, then decline to gn =6%.
a. If D0=$1.60 and re=10%, what should be TTC’s
stock worth today? What are its expected dividend
and capital gains yield at this time?

b. Now assume that TTC’s period of supernormal

growth is to last for 5 years rather than 2 years. How
would this affect the price, dividend yield and capital
gains yield now?

22 A three month CD is issued on 6 September 2019, 5.21%

and matures on 6 December 2019 ( Maturity 91
days). The CD requires a deposit of Rs.20,000,000
by the investor and assures an interest rate of 5.45%
to be paid at maturity along with the principal. What
is the yield realized by an investor who purchased on
6th Sep and sold on 11th October,2019 if the yield
for short 60 -day paper is 5.60% on 11th
October,2019? (Day count = actual/365)

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23 Suppose the direct quote for sterling in New York is 0.8997, 0.9001
1.1110‑5. $/£ .What is the direct quote for dollars in
London(£/$) ?

24 Mississippi Mud Pies, Inc. needs to buy 1,000,000 714,796$

Swiss francs (CHF) to pay its Swiss chocolate
supplier. Its banker in Switzerland quotes bid–ask
rates of CHF1.3990–1.4000/USD. What will be the
dollar cost of the CHF1,000,000?

25 Suppose the quote on British pounds is $1.624-31. $9957.08

a. If you converted $10,000 to British pounds

and then back to dollars, how many dollars would
you end up with? $232000

b. Suppose you are the dealer and could buy

pounds at the bid rate and sell them at the ask rate.
How many dollars would you have to transact in
order to earn $1,000 on a round-trip transaction
(buying pounds for dollars and then selling the
pounds for dollars)?

26 Suppose Dow Chemical (US company) receives 468450,

quotes of $0.009369-71 for the yen and $0.03675-6
for the Taiwan dollar (NT$). 9371000,

How many U.S. dollars will Dow Chemical receive 13,601,741

from the sale of ¥50 million?

What is the U.S. dollar cost to Dow Chemical of

buying ¥1 billion?

How many NT$ will Dow Chemical receive for

U.S.$500,000?

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