Lab 6 Bonds Robert Campbell and Carol Morris are senior vice presidents of the mutual of Chicago Insurance Company. They are co-directors of the companys pension fund management division, with Campbell having responsibility for fixed income securities (primarily bonds) and Morris being responsible for equity investments. A major new client, the California League of Cities, has requested that Mutual of Chicago present an investment seminar to the mayors of the represented cities. Campbell and Morris, who will make the actual presentation, have asked you to help them by answering the following questions: A. What are the key features of a bond? B. How do you determine the value of a bond? C. What is the value of a one year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent? What is the value of a similar 10 year bond? D. (1) What would be the value of the bond described in part c if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would it now be a discount bond or a premium bond? D. (2) What would happen to the bonds value if inflation fell, and rd declined to 7 percent? Would it have be a premium bond or a discount bond? E. Explain the following graph. F. (1) What is the yield to maturity on a 10 year, 9 percent annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between rd and the bonds coupon rate? F. (2) What is the current yield, the capital gains yield, and the total return in the preceding question? G. Use the following graph and answer the question, Which has the more interest rate price risk, a one year bond or a 10 year bond? Stocks Evaluation Assume that Bon Temps is a constant growth company whose last dividend (d0, which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6 percent rate. The appropriate rate of return for Bon Temps stock is 16 percent. A. (1) What is the firms expected dividend stream over the next three years? (2) What is the firms current stock price? (3) What is the stocks expected value one year from now? (4) What are the expected dividend yield, the capital gains yield, and the total return during the first year? B. Assume that the stock is currently selling at $21.20. What is the expected rate of return on the stock? C. Assume that bon temps is expected to experience supernormal growth of 30 percent for the next three years then to return to its long-run constant growth rate of 6 percent. What is the stocks value under these conditions? What is its expected dividend yield and capital gains yield in year 1? In year 4?