Prob 10-1 Compute the annual interest payments and principal amount for a Treasury Inflation-Protected Security with a par value of $1,000 Answer in the green shaded cells below

and a 3 percent interest rate if inflation is 4 percent in year one, 5 percent in year two, and 6 percent in year three.

Year Inflation Par Value Annual Coupon Interest

1

2

3

Prob 10-2 Judy Johnson is choosing between investing in two Treasury securities that mature in five years and have par values of $1,000. One is

a Treasury note paying an annual coupon of 5.06 percent. The other is a TIPS which pays 3 percent interest annually.

a. If inflation remains constant at 2 percent annually over the next five years, what will be Judy’s annual interest income

from the TIPS bond? From the Treasury note?

Year Par Value "Treasury Note

Annual Coupon Interest" Inflation Par Value "TIPS

Annual Coupon Interest"

1

2

3

4

5

Totals $- $- $-

b. How much interest will Judy receive over the five years from the Treasury note? From the TIPS?

Interest received from Treasury Note

Interest received from TIPS

c. When each bond matures, what par value will Judy receive from the Treasury note? The TIPS?

Par value from Treasury note

Par value from TIPS

d. After five years, what is Judy’s total income (interest par) from each bond?

Total income from Treasury note

Total income from TIPS

Should she use this total as a way of deciding which bond to purchase?

Prob 10-26 Mercier Corporation’s stock is selling for $95. It has just paid a dividend of $5 a share. The expected growth rate in dividends is

8 percent.

a. What is the required rate of return on this stock?

Required rate of return

b. Using your answer to (a), suppose Mercier announces developments that should lead to dividend increases of 10 percent

annually. What will be the new value of Mercier’s stock?

New value of Mercier stock

c. Again using your answer to (a), suppose developments occur that leave investors expecting that dividends will not change

from their current levels in the foreseeable future. Now what will be the value of Mercier stock?

New value of Mercier stock

d. From your answers to (b) and (c), how important are investors’ expectations of future dividend growth to the current stock price?

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