BAFI 355
BUSS207
Fall, 2019
Assignment 3
(Due by November 25, 2019)
Please solve the following questions. If you prefer to work in a group in completing this assignment, you
may do so. Groups are limited to a maximum size of 3 students. If you work in a group, the group will
turn in one solution to the assignment and everyone in the group will receive the same grade on the
assignment. If you work in a group, please make sure that you write down the names of all of your group
members. If more than one group works together and turns in, substantially, the same work, this violates
the rules of the course and the rules on academic integrity, and penalties will be assessed. The assignment
is due at the beginning of class on the due date. Please show all the intermediate steps and calculations
when solving the problems and state your assumptions (if any). Please type your answers.
1. Use the following corporate bond quote information to answer the questions that follow.
Since this is a corporate bond, assume the company makes semi-annual coupon payments
and also assume the bond matures on today’s date (Nov. 28) in its maturity year and the
par value is $1,000. The price is a dollar term.
Company Coupon Maturity Price Yield
XYZ Inc XXXXXXXXXXNov. 25,
2024
976.67
a. What is the bond’s yield to maturity?
. If your required return is 9% APR, would you buy this bond today? Show work to
prove why or why not.
2. A year ago, you purchased two bonds issued by the same company, ABC Co. : (1) a 20-
year $1,000 par value, annual coupon bond with a 7 percent coupon rate, and (2) a 5-year
$1,000 par value, annual coupon bond also with a 7 percent coupon rate. Both bonds had
a yield to maturity (required rate of return) of 9 percent when you bought them.
a. What price did you pay for each bond a year ago?
. Today, assume the yield to maturity on both bonds is 11 percent. What is total rate
of return on each bond if you sell these bonds today?
c. Now, imagine today's yield to maturity is 13 percent for each bond. Unfortunately,
you need cash from selling these bonds for your winter vacation trip to Aspen and
Jamaica. What is total rate of return on each bond if you sell these bonds today?
d. Examine your answers for each bond from questions b and c. Which bond had the
est return in each question and why? What bond risk concept does this problem
illustrate?
3. Your stock
oker, John Smith, calls you with a hot stock tip to buy SMITH Inc. The
stock is cu
ently selling for $25 a share. You gather the following data to evaluate
Smith's recommendation. The risk free rate is 3%, and you demand a 14% return on the
market portfolio. SMITH's cu
ent dividend is $2.50 a share. You decide to get other
necessary estimates from a third-party, Rocky Enterprises. Rocky has estimated that
SMITH's beta is 2.0 and that the stock's dividend will grow at a constant 10 percent rate.
Based on your estimates, is Smith's recommendation to buy SMITH a good one? What do
you think the stock is worth?
4. Mark Smith, the new CFO of ITG is considering increasing the company’s growth rate
entering a new line of business. Cu
ently, ITG has a cu
ent dividend of $1.50 per share
and its dividend is expected to grow at a constant rate of 8%. The company’s beta is 1.5
and the risk free rate is 3% and the market risk premium is 9%. Mark Smith has
consulted some security analysts and told them about the new line of business he is
considering. These analysts say if ITG enters this new line of business their growth rate
in dividends and earnings will increase to a constant rate of 13% per year, but the
company will have more market risk causing its beta to rise to 1.9. Now Mark needs
your help. Should ITG enter this new line of business? Show your work to justify your
ecommendation.
5. Here are some analysts’ estimates for Citigroup (the banking and financial services giant)
common stock. The recent price of this stock was $33
a. Analyst 1 has the following growth estimates. Given the following information what
is the analyst’s value for Citigroup? What should the analyst recommend based on
the recent price of $33?
• Cu
ent Dividend Per Share $0.72
• Required Rate of Return XXXXXXXXXX% or 0.12
• Annual Dividend Growth Rate, year XXXXXXXXXX% or 0.16
• Annual Dividend Growth Rate, year 4 to infinity 9% or 0.09
. Analyst 2 thinks Citigroup is a constant growth stock. He expects a constant growth
ate of 10% of Citigroup’s cu
ent dividend of $0.72 and estimates a required return
of 12.5%. What is this analyst’s value for Citigroup? What should the analyst
ecommend based on the recent price of $33?
c. Citigroup's recent stock price is $33, and its cu
ent dividend is $0.72 a share. Now,
let's assume that Citigroup is a constant growth stock with a required return of 12%.
What is Citigroup's expected annual constant growth rate assuming the recent $33
stock price is in equili
ium?
a. What price did you pay for each bond a year ago?
b. Today, assume the yield to maturity on both bonds is 11 percent. What is total rate of return on each bond if you sell these bonds today?
c. Now, imagine today's yield to maturity is 13 percent for each bond. Unfortunately, you need cash from selling these bonds for your winter vacation trip to Aspen and Jamaica. What is total rate of return on each bond if you sell these bonds today?
d. Examine your answers for each bond from questions b and c. Which bond had the best return in each question and why? What bond risk concept does this problem illustrate?
3. Your stock
oker, John Smith, calls you with a hot stock tip to buy SMITH Inc. The stock is cu
ently selling for $25 a share. You gather the following data to evaluate Smith's recommendation. The risk free rate is 3%, and you demand a 14% return o...