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4540e1f10key

# 4540e1f10key - AP/ADMS 4540 Financial Management Fall 2010...

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AP/ADMS 4540 Financial Management Fall 2010 Exam 1 Answer Key Question 1 (10 marks) Calculate the RVs, WVs, price, duration and volatility of a 5-year, \$1,000 face value, 14 percent coupon bond yielding 13 percent with coupons paid annually. Why are duration and volatility important? Using its duration and volatility, calculate what happens to the price of the bond when the yield to maturity rises to 14 percent. Time Payment PV RV WV 1 140 123.89 0.11968 0.11968 2 140 109.64 0.10591 0.21182 3 140 97.03 0.09373 0.28119 4 140 85.86 0.08294 0.33176 5 1,140 618.75 0.59774 2.98870 Bond Price =1,035.17 1.00000 3.93315=Duration (5 marks) Duration is important as the longer the duration, the greater the risk from interest rate changes. Therefore we should always try to match the duration of the portfolio of assets to the holding period. For a corporate financial manager, the duration of corporate assets should be matched to the duration of corporate liabilities. (2 marks) Duration = D = 3.93315 years Volatility = v = D/(1+r) = -3.93315/1.14 = -3.48% (1 mark) When yield rises by one percent, price falls by 3.48% or \$36.02 (1 mark) New price = \$1,035.17+\$36.02 = \$999.15. (1 mark) Question 2 (20 marks) With Canadian interest rates still at historical lows, McGraw-Hill-Ryerson (MHR) is considering whether to take advantage of its lower cost of debt and refund its old bonds. Suppose the old issue comprises \$25 million, 12 percent coupon rate (paid yearly) 20-year bonds that were sold 5 years ago. A new issue of \$25 million, 15-year bonds can be sold with a coupon rate of 10 percent (paid yearly). A call premium of 9 percent will be required to

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4540e1f10key - AP/ADMS 4540 Financial Management Fall 2010...

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