Ch 4 Solutions Rev CF2.feb067

Ch 4 Solutions Rev CF2.feb067 - Valuation 41 Chapter 4:...

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Unformatted text preview: Valuation 41 Chapter 4: Valuation Answers to end-of-chapter questions 4-1. Using a numerical example to illustrate, you issue a $1,000 face value 10-year bond, with a coupon of $80. Interest rates fall to 6%. The coupon rate is still 8%. The bonds price is now $1,147. The coupon yield is 80/1147 = 0.07 or 7%. The yield to maturity is 6%, the going interest rate for bonds of this type. The coupon rate will be the highest number of the three and the yield to maturity the lowest. 4-2. The treasury bonds will all carry the same default risk none and the same maturity risk (5 years.) They all should be trading at about the same yield to maturity. 4-3. Interest rate risk is higher for longer term bonds. This is because you will be receiving the cash flows from the bond further in the future. A change in interest rates will result in a bigger price change for a longer term bond than for a shorter term bond. A simple way to assess and compare default risk among bonds is to evaluate their credit rating by firms such as Moodys, Standard & Poors and Fitch. 4-4. Under the expectations hypothesis, there is no maturity risk premium, so interest rates are the same for bonds with the same risk but different maturities. An upward sloping yield curve would mean that investors expect short term rates to rise. 4-5. The bond prices will increase which means the yield to maturity is decreasing. 4-6. Internet/newspaper exercise. 4-7. The yield curve is typically upward sloping. 4-8. The yield curve is typically downward sloping preceding recessions. 4-9. The level of interest rates was substantially higher in the late 1970s and early 1980s. Investors expected interest rates to come down and lowered long-term interest rates accordingly. Interest rates in the 1990s have been much lower than average, reflecting very low inflation expectations. 4-10. This statement is incorrect. While the dividend growth model cant be used, the model is still valid. Even if a firm does not pay a dividend and has no intention of declaring a dividend, at the very least it will have a liquidating dividend. At some point, when the company dissolves or is acquired, it will pay stockholders their share of the firms assets in liquidation. The present value of this expected future, liquidating dividend is the value of the stock price today. If there is a secondary market for the security, then this value can be claimed at any time in the form of capital gains. 4-11. A company experiencing rapid growth may not be able to sustain that growth. Investors may have more difficulty valuing a high growth company and be become overly optimistic about the company, pushing the price higher than future cash flows warrant. If the price has been pushed too high, in other words, the company is overpriced, then the investor may lose when the market later corrects for the overpricing....
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Ch 4 Solutions Rev CF2.feb067 - Valuation 41 Chapter 4:...

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