Question
part a): Several years ago, Castles in the Sand, Inc., issued bonds on face value at a yield to maturity of 8 percent. Now, with
part a):
Several years ago, Castles in the Sand, Inc., issued bonds on face value at a yield to maturity of 8 percent. Now, with 8 years left until the maturity of the bonds, the company has run into hard times and the yield to maturity on the bonds has increased to 14 percent. What has happened to the price of the bond? Suppose that investors believe that Castles can make good on the promised coupon payments, but that the company will go bankrupt when the bond matures and the principal comes due. The expectation is that investors will receive only 80 percent of face value at maturity. If they buy the bond today, what yield to maturity do they expect to receive?
part b).
Phoenix Industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another 2 years. After the third year (in which dividends are $3 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 6 percent. If the firm's investors expect to earn a return of 14 percent on this stock, what must be its price?
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