03-midterm_sol

03-midterm_sol - MIT Sloan School of Management J. Wang...

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MIT Sloan School of Management J. Wang 15.407 E52-456 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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03-midterm_sol - MIT Sloan School of Management J. Wang...

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