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MIT Sloan School of Management
J. Wang
15.407
E52456
Fall 2003
Midterm Solution
1.
(a) False. If the cashﬂows are of diﬀerent risk nature and timing, then you need to use
the corresponding discount rate for each cashﬂow.
(b) False. Normally, the value of a bond decrease when interest rate rise because the
present value of future payments are decreased. However, there is an additional
eﬀect of the reverse ﬂoater that the promised payment is decreased, pushing the
price even further down. Therefore, the modiﬁed duration on a reverse ﬂoating
must be higher than the its straight bond counterpart.
(c) False. If an investor is short term, i.e. he plans to sell the stock after a few dividend
payment, then when he sells the stock, the price he could sell is still the discounted
value of all future dividends. Therefore, the value of the stock to him, which is the
discounted value of all the dividends he gets before he sells the stock plus the resell
value of the stock, is the same as that is predicted by the DDM.
(d) False. A growth company has investment opportunities with expected return higher
than the required rate of return. However, earnings may not be growing. For
example, the ﬁrm could be investing heavily, leading to lower current earnings.
(e) False. If the dividend yield exceeds the corresponding spot riskless rate, then the
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 Fall '03
 Wang

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