1. You bought a 1year 10,000 Treasury bill for 9,090 and held it until maturity. The inflation rate during

the year was 5%.

a. What was your real rate of return?

b. If interest income is subject to 12% income tax, what will be your real rate of return after

taxes?

2. You have just purchased a 1,000 bond with 7% annual coupon and maturity in 10 years.

a. If the yieldtomaturity is 6%, how much did you pay for the bond?

b. If, 1 year later and on the day after you receive the first coupon, the bond's yieldtomaturity

goes up to 8%, and you need cash and have to liquidate your investment. What will be your

selling price?

c. What will be your 1year holding period rate of return?

3. A company just paid a dividend of 1.00 per share (D0 = 1.00). Analysts expect the dividends to grow

20% this year (D1 = 1.20), and 15% next year. After two years, the dividend is expected to grow at a

constant rate of 5%. The required rate of return on the company's stock is 12 percent. If the stock in is

currently trading at 15/share in Borsa Istanbul, would you buy the stock?

4. A publiclyheld corporation has a total debt of 12 million with an average interest cost of 15%. The

company has outstanding 1 million shares of common stock, currently traded at a price of 10/share

in Borsa stanbul. The company is subject to a 20% corporate tax rate.

a. If the riskfree rate of interest (current yield on shortterm Tbills) is 8%, the stock market is

expected to return 18% next year and the company's estimated (CAPM) beta is 1.5, what is

the required rate of return on its equity?

b. Calculate the company's weighted average cost of capital.

5. The firm in Question 4 is considering a new project, which requires an initial investment in equipment

of 90,000 and also an initial investment in working capital of 10,000 (at t = 0). You expect the project

to produce sales revenue of 120,000 per year for three years. You estimate manufacturing costs at 60%

of revenues. (Assume all revenues and costs occur at yearend) The equipment fully depreciates using

straightline depreciation over three years. At the end of the project, the firm can sell the equipment

for 10,000 and also recover the investment in net working capital.

a. Find the project's payback period, IRR, NPV and profitability index.

b. Should the company invest in the project? Explain.

c. Does your decision in (b) depend on the way the project is financed? If so, how?

6. Currently, the yieldtomaturity on zerocoupon 10year US Treasury bonds is 0.66%

(0.0066 < 1%). You buy these bonds at $936 per bond and plan to keep them as a "safe" longterm

investment (say, 4 - 5 years). The face value is $1,000 at maturity.

a. Suppose that, starting next year, interest rates start increasing at a speed of 1% per year

(1.6% in 2021, 2.6% in 2022 and so on) and the yield on these bonds follow a similar upward

trend. What will the prices of the 10year bonds in years 2021 through 2030? What will be

your rate of return if you sell your bonds in 2023?

b. Suppose interest rates do not change much but the average rate of inflation over the next

10 years turns out to be 2.5% per year. What will be your real rate of return if you keep the

bonds until maturity?

c. Do you still want to invest in these bonds? Why or why not?