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ASSIGNMENT #2
The purpose of this assignment is to solidify your understanding on the applications of the risk
and return concepts and their role in valuing financial assets. The scores of this assignment will
help in assessing the following learning goal of the course: “students successfully completing
this course will be able to Analyze risk return characteristics to assess valuation of financial
assets”.
Instructions:
You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems
(provided on page 3) related to the risk and return, stocks and bonds valuation. You are required
to show the following 3 steps for each problem (sample questions and solutions are provided for
guidance):
(i) Describe and interpret the assumptions related to the problem.
(ii) Apply the appropriate mathematical model to solve the problem.
(iii) Calculate the co
ect solution to the problem.
Sample Questions and Solutions
Sample Question # 1:
A company has an issue of 12-year bonds that pay 5% interest, annually. Further assume that
today's required rate of return on these bonds is 7%. How much would these bonds sell for
today? Round off to the nearest $1.
Solution
(i) The problem assumes that the face value of the bond is $1000. The bond will pay an
annual coupon of 5% i.e., coupon or interest amount of $50 is assumed to paid every
year. It also assumes that investors cu
ently required a return of 7% on investments
with similar risk characteristics. The use of bond valuation concept is appropriate to
calculate the true value of these bonds. The accuracy of the solution depends on the
co
ectness of the assumptions on face value, coupon payments and required rate of
eturn assumption.
(ii) The use of bond valuation concept which suggests that the true value of a bond is the
present value of its future coupon and face value discounted at investors required rate
of return is appropriate to calculate the true value of these bonds. We are required to
compute the present value (PV) which represents the true value of the bond.
(iii) FV= $1000; PMT=$50; Rate = 7%; N=12 years; Compute PV = ? $841.15
Value of the Bond = $841.15
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Sample Question # 2:
A company just paid a dividend of $1, and the dividends are expected to grow at constant rate of
4% forever. If the required return of the stockholders is 12%, what is the price of this company’s
stock?
Solution
(i) The problem assumes the stock will have a constant growth of 4% forever. The
constant growth model is appropriate to use for this problem. The accuracy of the
solution depends on the co
ectness of the constant growth assumption.
(ii) The constant growth model is given as: P0 = D1/ (R-g); where
P0 is the cu
ent price to be calculated,
D1 is the next period’s dividend,
R is the required return on this stock
g is the constant growth
D1 needs to be calculated in order to apply this model.
(iii) D1= 1x(1+0.04) = 1.04
P0 = 1.04 / XXXXXXXXXX) = $13; the stock price should be $13 based on the constant growth
model.
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Assignment Problems
1. Han Corporation issues a bond which has a coupon rate of 9.40%, a yield to maturity of 7.75%,
a face value of $1,000, and a market price of $990. What is the semiannual interest payment?
Round to two decimal places.
2. A shipping company sold an issue of 14-year $1,000 par bonds to build new ships. The bonds pay
10% interest, compounded semiannually. Today's required rate of return is 8.50%. How much
should these bonds sell for today? Round to two decimal places.
3. Assume a company has an issue of 30-year $1,000 par value bonds that pay 4.75% interest,
compounded annually. Further assume that today's required rate of return on these bonds is
3.25%. How much would these bonds sell for today? Round to two decimal places.
4. Atlantis Company issued bonds on January 1, 2006. The bonds had a coupon rate of 6.0%, with
interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January
1, 2024. What is the yield to maturity for these bonds on January 1, 2019 if the market price of the
ond on that date is $1,150? Submit your answer as a percentage and round to two decimal places.
5. A $1,000 par value 8-year bond with a 13 percent coupon rate recently sold for $980. What is the
yield to maturity if the bond makes semiannual payments? Submit your answer as a percentage
ounded to two decimal places.
6. Consider a 7 year bond with face value $1,000 that pays an 8.4% coupon semi-annually and has a
yield-to-maturity of 6.9%. What is the approximate percentage change in the price of bond if
interest rates in the economy are expected to increase by 0.40% per year? Submit your answer as a
percentage and round to two decimal places. (Hint: What is the expected price of the bond before
and after the change in interest rates?)
7. Nippon, Inc. expects its cu
ent annual $3.30 per share common stock dividend to remain the
same for the foreseeable future. What is the intrinsic value of the stock to an investor with a
equired return of 9.2%? Round to two decimal places.
8. Hackworth Company's common stock is expected to pay a $6.10 dividend in the coming year. If
investors require an 11% return and the growth rate in dividends is expected to be 7%, what
should the market price of the stock be? Round to two decimal places.
9. Nell Corporation stock is cu
ently selling for $15.50. The stock is expected to pay a dividend of
$1.75 at the end of the year. Dividends are expected to grow at a constant rate of 6% indefinitely.
Compute the expected rate of return on Nell Corporation stock. Submit your answer as a
percentage and round to two decimal places.
10. Finkle-McGraw Corp. just paid a dividend today of $2.60 per share. The dividend is expected to
grow at a constant rate of 4.6% per year. If Finkle-McGraw Corp. stock is selling for $72.00 per
share, what is the stockholders' expected rate of return? Submit your answer as a percentage and
ound to two decimal places.
Grading Ru
ic
Learning Objective Subcomponent Not Submitted
0
Does Not Meet
Expectations
1
Meets
expectations
2
Exceeds Expectations
3
The student will make No attempt made Attempts to describe Explicitly describes Explicitly describes assumptions
and evaluate important assumptions assumptions and provides rationale for why
assumptions in each assumption is appropriate.
identification of Show awareness that confidence
appropriate asset in final conclusions is limited by
valuation variables and the accuracy of the
risk and return measures assumptions (e.g., provides
descriptions about the
assumptions of the model and its
limitations; lists and describes
each variable within the model)
The student will convert No attempt made Completes conversion Completes Relevant information is
relevant information into of information but conversion of expressed in an insightful
LO#2: Analyze risk
eturn characteristics
to assess valuation of
financial assets.
various mathematical
forms (e.g., equations,
graphs, words)
resulting mathematical
portrayal is
inappropriate or
inaccurate
information into
mathematical
portrayal
mathematical portrayal in a way
that contributes to a further or
deeper understanding (e.g.,
co
ect variables are selected and
the mathematical model is
portrayed with the co
ect
variables)
The student will calculate No attempt made Calculations are Calculations are Calculations attempted are
risk and return measures attempted but are both attempted to solve essentially all successful and
and asset values unsuccessful and not the problem but not sufficiently comprehensive to
comprehensive comprehensive solve the problem. Calculations
are also presented
elegantly (e.g., provides insights
on the interpretation of the
calculated value of an asset such
as the value of a stock is valid
only within the context of the
model and its limitations)
The above ru
ic will be applied to grade each question and the average score will be calculated for each subcomponent.
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