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Robert Balik and Carol Kiefer are senior vice-presidents of the Mutual of Chicago Insurance Company.

Robert Balik and Carol Kiefer are senior vice-presidents of the Mutual of Chicago Insurance Company.  They are co-directors of the company's pension fund management division, with Balik having responsibility for fixed income securities (primarily bonds) and Kiefer being responsible for equity investments.  A major new client, the California League of Cities, has requested that Mutual of Chicago present an investment seminar to the mayors of the represented cities, and Balik and Kiefer, who will make the actual presentation, have asked you to help them.
To illustrate the common stock valuation process, Balik and Kiefer have asked you to analyze the Bon Temps Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads.  You are to answer the following questions
a. What are the key features of a bond?
b. What are the call provisions and sinking fund provision? Do these provisions make
bonds more or less risky?
c. How is the value of any asset whose value is based on expected future cash flows
determined?
d. How is the value of a bond determined? What is the value of a 10 year, $1,000 par
value bond with a 10% annual coupon if its required rate of return is 10%?
e.
(1) What would be the value of the bond described in part d, if just after it had been
issued, the expected inflation rate rose by 3 percentage points, causing investors to
require a 13% return? Would we now have a discount or a premium bond?
(2) What would happen to the bond´s value if inflation fell, and kd declined to 7%?
Would we now have a premium or a discount bond?
f. What is a bond spread and how is it related to the default risk premium? How are
bond ratings related to default risk? What factors affect a company´s bond rating?

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