Question 1: Why do you think a corporation that is considering investing in a long-term project that will not generate any positive cash flow for several years would fund it by issuing zero-coupon bonds?
Question 2: Which would you expect to have higher interest rates: debentures or mortgage-backed bonds? Please justify your response.
Question 3: What is the difference between a "call" and a "put?" Which party in a bond transaction would prefer the "call" and which the "put?"
Question 4: Would you classify the relationship between bond ratings and the required return on the bond issue as direct or inverse? Why?
Question 5: The price (pv) of a bond is determined by the relationship of the bond's current yield-to- maturity (market rate of interest) to the bond's coupon rate. Please explain under what circumstances the bond will trade (1) at par, (2) at a discount and (3) at a premium in the market.
Question 6: Why is preferred stock referred to as a "hybrid?" Compare and contrast its specific features to bonds and common stock.
Question 7: How is the Dividend Discount Model of valuing equities similar to the method we learned to value bonds?
Calculation Problems (please show your work for possible partial credit):
1. We learned that the current market price of a bond is the total of the present values of (1) the principal/face/par value (future value) of the bond and (2) the income stream of interest payments (annuity). For a $1,000 par bond maturing in 10 years with a coupon rate of 5% making annual interest payments and a market yield (ytm) of 5%, calculate the PV's of (1) and (2) above. (Hint: combined, they will total the par or future value of the bond of $1,000 since ytm = coupon rate). Show your calculations.
2. What would you be willing to pay (pv) for a 20-year bond that has a maturity value of $1,000 and makes semi-annual interest payments of $40, if you require a 10% annual yield?
3. What would be the price of a bond that pays $37.50 interest every 3 months that will mature in 15 years with a $1,000 face amount when you require an annual rate of return of 12%?
4. A share of preferred stock pays an annual dividend of $6 per share. If investors require a 12% return, what is the price of this preferred stock?
5. The most recent dividend on Spirex Corp's common stock was $4.00 and the expected growth rate is 10%. If the required rate of return is 20%, what is the highest price you should be willing to pay for this stock?
6. Suppose you are willing to pay $30 today for a share of stock which you expect to sell at the end of the year for $32. If you require an annual rate of return of 12%, what must be the amount of the annual dividend you expect to receive for the year?