ASSIGNMENT QUESTIONS:

IMPORTANT: SHOW YOUR DETAILED SOLUTIONS FOR EACH QUESTION.

Problems: (60%)

1. Butbol Club Barcelona is experiencing a tough cash situation after the Covid 19 situation. As a consequence the management is planning to issue bonds with the following characteristics:

Par: €1000

Time to maturity 20 years

Coupon rate 8%

Semiannual payments

The price of the bonds are going to be different depending on the Yield to maturity, the expectations are:

25% Chances YTM:5%

35% Chances YTM:6%

40% Chances YTM:7%

Calculate the price of the bond for each of the cases.

2.- The Tornado Corp. has a 6 percent coupon bond outstanding. The Waves Corp has a 12 percent bond outstanding. Both bonds have 9 years to maturity, make semiannual payments, and have a YTM of 9 percent.

If interest rates suddenly rise by 3 percent, what is the percentage change in the price of these bonds? What if interest rates suddenly fall by 3 percent instead?

3.- Suppose that today you buy a 2 percent annual coupon bond for €1020. The bond has 10 years to maturity. What rate of return do you expect to earn on your investment?

Two years from now, the YTM on your bond has declined by 1 percent, and you decide to sell. What price will your bond sell for? What is the Holding Period Yield on your investment? Compare this yield to the YTM when you first bought the bond. Why are they different?

4.- Damm Corporation stock currently sells for €5 per share. The market requires a return of 11.6percent on the firm’s stock.

If the company maintains a constant 2 percent growth rate in dividends, what was the most recent dividend per share paid on the stock?

5.- DAPSA Corp currently has an EPS of €5, and the benchmark PE for the company is 41.

Earnings are expected to grow at 3 percent per year.

1. What is your estimate of the current stock price?

2. What is the target stock price in one year?

6.- Consider four different stocks, A, B, C and D, all have a required return of 15 percent and a most recent dividend of €5 per share. Stocks A,B, and C are expected to maintain constant growth rates in dividends for the future of 5 percent, 0 percent, and −5 percent per year, respectively.

Stock D is a growth stock that will increase its dividend by 20 percent for the next 3 years and then maintain a constant 6 percent growth rate thereafter.

What is the dividend yield for each of these four stocks? What is the expected capital gains yield?

Questions (40%)

1.- How does a bond issuer decide on the appropriate coupon rate to set on its bonds?

Explain the difference between the coupon rate and the required return on a bond.

2.- What is the difference between the term structure of interest rates and the yield curve?

3.- What is the relationship between the price of a bond and its YTM?

4.- What are the three factors that determine a company’s price–earnings ratio?

5.- Under what two assumptions can we use the dividend growth model to determine the value of a share of stock? Comment on the reasonableness of these assumptions.

6.- Why might a company choose not to pay dividends?

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