16. Interest Rate Risk. Both Bond Bill and Bond Ted have 7 percent coupons, make semiannual payments, and are priced at par value. Bond Bill has 3 years to maturity, whereas Bond Ted has 20 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Bill? Of Bond Ted? If rates were to suddenly fall by 2 percent instead, what would the percentage change in the price of Bond Bill be then? Of Bond Ted? Illustrate your answers by graphing bond prices versus YTM. What does this problem tell you about the interest rate risk of longer-term bonds?

6.16. Find % Change of Bond Bill and Ted. Hint: Percentage change in price = (New price Original price) / Original price

a. If the YTM suddenly rises to 9 percent: (Show work):

1. DP_Bill% =

2. DP_Ted% =

b. If the YTM suddenly falls to 5 percent: (Show work):

1. DP_Bill% =

2. DP_Ted% =

c. Graph (Import graphic):

d. What does this problem tell you about the interest rate risk of longer-term bonds?

_____________________________________

Valuing Preferred Stock. E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will pay a $20 dividend per year, but the first dividend will not be paid until 20 years from today. If you require a return of 8 percent on this stock, how much should you pay today?

7.11. With a return of 8 percent on this stock, how much should you pay? Hint: Once the stock begins paying dividends, it will have the same dividends forever, a preferred stock. We value the stock at that point, using the preferred stock equation. It is important to remember that the price we find will be the price one year before the first dividend (Show work):

P₀ =

_______________________________________

Stock Valuation. Alexander Corp. will pay a dividend of $2.72 next year. The company has stated that it will maintain a constant growth rate of 4.5 percent a year forever. If you want a return of 12 percent, how much will you pay for the stock? What if you want a return of 8 percent? What does this tell you about the relationship between the required return and the stock price?

7.12. Value a stock with two different required returns. Use the constant growth model.

Price @ required return of 12%: (Show work):

P₀ =

b. Price @ required return of 8%: (Show work):

P₀ =

c. What does a higher required return mean to the stock?