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quiz2_w07b_ans - Note In responding to"WHY/Explain you...

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Note: In responding to "WHY/Explain" you should N AME ________________________________ give a meaningful explanation that would convince a skeptic. S CHOOL   OF  B USINESS  A DMINISTRATION F INANCE  350 Q UIZ  #2 P ROF . J ARRAD  H ARFORD 1. The price of a one-year strip is 95:08. The yield curve tells you that the spot rate for a term of 6 months is 5% APR, compounded semi-annually. What is the price of a one-year 4% coupon bond with its next coupon due in 6 months? (2pts) 4% coupon means 4% of $1000 paid in semi-annual installments: $20 every 6 months. So the CF from the bond are: 6 MONTHS 1 YEAR 20 1020 95:08 means that 95 8/32 today gets you 100 in one year, or $95.25 is the PV of $100. Thus, $0.9525 is the PV of $1. Then the PV of $1020 in one year is 0.9525(1020)=971.55 The only thing left is the PV of the CF in 6 months. We are given the 6 month rate as 5% APR, compounded semi-annually. So, the price of the bond is $19.51 + $971.55 = 991.06 2. What is the connection between NPV and shareholder wealth? (2pts) Net Present Value is equal to the total effect on the value of the firm (in present value) of the project. Since total shareholder wealth is simply the value of the equity in the firm, the NPV
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