Question $1$

Both Bond Sam and Bond Davy have $7\mathrm{.}1$ percent coupons, make semiannual payments, and

are priced at par value. Bond Sam has $3$ years to maturity, whereas Bond Dave has $20$ years to

maturity. If interest rates suddenly rise by $2$ percent, what is the percentage change in the price

of Bond Sam? Of Bond Dave? If rates were to suddenly fall by $2$ percent instead, what would

the percentage change in the price of Bond Sam be then? Of Bond Dave? Illustrate your

answers by graphing bond prices versus YTM$.$ What does this problem tell you about the

interest rate risk of longer$-$term bonds?

Question $2$

Most corporations pay quarterly dividends on their common stock rather than annual dividends.

Barring any unusual circumstances during the year, the board raises, lowers, or maintains the

current dividend once a year and then pays this dividend out in equal quarterly installments to

its shareholders.

a$.$ Suppose a company currently pays an annual dividend of $$3\mathrm{.}60$ on its common stock in a

single annual installment, and management plans on raising this dividend by $3\mathrm{.}4$ percent per

year indefinitely. If the required return on this stock is $10\mathrm{.}5$ percent, what is the current share

price?

b$.$ Now suppose the company in $($a$)$ actually pays its annual dividend in equal quarterly

installments; thus, the company has just paid a dividend of $$\mathrm{.}90$ per share, as it has for the

previous three quarters. What is your value for the current share price now? $($Hint: Find the

equivalent annual end$-$of$-$year dividend for each year.$)$ Comment on whether you think this

model of stock valuation is appropriate.