Consider

Airnova Inc. has two types of bonds, Bond D and Bond F. Both have 8 percent coupons, make semiannual payments, and are priced at par value. Bond D has 2 years to maturity. Bond F has 15 years to maturity.

Airnova Inc. is considering four different types of stocks. They each have a required return of 20 percent and a dividend of $3.75 for share. Stocks, A, B, and C are expected to maintain constant growth rates in dividends for the near future of 10 percent, 0 percent, and -5 percent, respectively. Stock D is a growth stock and will increase its dividend by 30 percent for the next four years and then maintain a constant 12 percent growth rate after that.

Discuss

• If interest rates suddenly rise by 2 percent, what is the percentage change in both bonds?

• If interest rates suddenly fall by 2 percent, what is the percentage change in both bonds?

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

• What is the dividend yield for each of the four stocks?

• What is the expected capital gains yield?

• Discuss the relationship among the various returns that you find for each of the stocks.