Fixed Income

Use the following information to solve problems 1 8 Suppose Tesla decides to issue bonds to finance its acquisition of Twitter. The bond is issued with 10 years to maturity and a coupon rate of 5%. Assume the term structure is flat, the bond is priced with a yield-to-maturity of 5.5%, the bonds face value is $1,000, and that it pays coupons once per year at the end of the year.

1. Calculate the price of the bond at issuance.

2. Assume the bond is callable beginning in 5 years. Calculate the bonds yield to call, with the following call schedule: Year 5: $1,050, Year 6: $1,040, Year 7: $1,030, Year 8: $1,020, Year 9: $1,010

3. Calculate the bonds modified duration at issuance.

4. Use modified duration from question 3 to estimate the dollar change in bond value if yields increase by 1% just after issuance.

5. Assume convexity is equal to 73.78 for this bond. Estimate the dollar change in the bond value if yields increase by 1% just after issuance using the modified duration from question 3 and the convexity adjustment.

6. Calculate the actual change in the bonds value if yields increase by 1% just after issuance. Calculate the percent error for the duration approximation and for the duration-with-convexity approximation. What do you conclude?

7. Assume coupons can be reinvested at 6% and in 3 years the bond is priced to yield 6% to maturity. Calculate the 3-year holding period return and the horizon yield (realized compound return).

8. Suppose the UK pension system buys $5 million of Tesla bonds to pay for retirement liabilities. The boss of the pension system, Mel Stride, is concerned about rising interest rates and wants to fully immunize this portfolio of bonds. Mel plans to use zero coupon bonds with a modified duration of 5 years to immunize the portfolio. How much of the zero-coupon bonds does he need to sell short to immunize the portfolio?

Equities Use the following information to solve problems 9 21 Find the FRED Economic Data website maintained by the St. Louis Fed. Find the 3-month treasury bill yield to maturity at the end of the day on Friday, November 4, 2022. Search for the 3-month risk-free rate. The series you find should be Market Yield on U.S. Treasury Securities at 3-Month Constant Maturity, Quoted on an Investment Basis. Next, find AT&Ts stock on the Yahoo!Finance website. Document the following: From the Summary tab near the top of the page, find Beta (5 Yr Monthly). From the Financials tab near the top of the page, find the Cash Dividends Paid, Operating Cash Flows, Capital Expenditures, Net Long Term Debt Issued, and Net Short Term Debt Issued found on the cash flow statement and the Diluted NI Available to Com Stock on the income statement for the year ending 12/31/2021. From the Statistics tab near the top of the page, find the Return on Equity (ttm) Shares Outstanding, Trailing P/E, and Quarterly Earnings Growth (yoy). From the Historical Data tab near the top of the page, find the Adj Close price at the end of the day on Friday, November 4, 2022.

9. Assume the expected return to the market is 8.5%. Calculate the equity cost of capital (k) assuming a CAPM world.

10. Calculate the firms retention rate (aka, plowback ratio).

11. Calculate the fundamental growth rate for AT&T.

12. Calculate the fundamental forward P/E ratio for AT&T. Using the closing price on Friday (11/4/2022), calculate the implied forward earnings per share.

13. Using your answer to questions 12, calculate the intrinsic value for AT&T (i.e., share price today) assuming its P/E ratio is equal to the fundamental P/E ratio and its earnings per share is equal to the implied earnings.

14. Calculate the annual dividends paid on a per share basis at the end of 2021.

15. Calculate the intrinsic stock price of AT&T using the Dividend Discount Model (DDM) and your answers to questions 9 12.

16. If you believe your intrinsic value is correct (question 15), is AT&T overpriced or underpriced relative to the closing price on Friday (11/4/2022)? Explain.

17. Calculate Free Cash Flow to Equity Model (FCFE) on a per share basis at the end of 12/31/2022 using the method that starts with the Operating Cash Flow (CFO). (Ignore the free cash flow number provided on the site at the bottom of the cash flow statement, this is the free cash flow to the firm.)

18. Calculate the intrinsic value of AT&T shares using the FCFE model.

19. Using your calculation for the FCFE on a per share basis (question 17), assume instead a two-stage growth model. For the first three years, assume AT&T will grow FCFE according to the fundamental growth rate (answer to question 11). Thereafter, FCFE will grow according to the Quarterly Earnings Growth found on the Yahoo!Finance site. Calculate the intrinsic value.

20. Go the Statistics tab for AT&T, Verizon, and T-Mobile on Yahoo!Finance and find the valuation measures for these three companies for the current period. Compare the forward P/E ratio to the PEG ratio. Which firm has the lowest implied growth rate?

21. Which firm looks more attractive as a buy based on the PEG ratio? Based on the trailing P/E ratio, which stock is a better buy for value investors?