Questions 1 through 19 are related.

An issue of 8.5% Series C preferred stock has a par value of $75 million or $40 per share and was sold to investors several years ago at par. According to the terms of the issue, the preferred is scheduled to be redeemed in 25 years at its par value of $40 per share. Dividends are paid quarterly but analyzed as if paid annually. The stock is currently trading at a discount for $35 per share.

1. Which of the factors listed below could have contributed to the stock trading at $35 per share instead of the par value of $40?

1. Interest rates have increased since the preferred was issued.
2. Interest rates have decreased since the preferred was issued.
3. The issuers debt/equity ratio has decreased significantly since the preferred was issued.
4. The issuers net income and free cash flow have increased significantly since the preferred was issued.
5. Answers a, c, and d are correct.

2. As a prospective investor in this preferred, what is the expected rate of return to redemption in 25 years? Assume dividends are paid annually and it is exactly 1 year to the next dividend.

1. 4.93%
2. 5.05%
3. 8.50%
4. 9.86%
5. 10.11%

3. Using Macaulays Duration [but on an annual basis rather than semi-annual because m = 1], the Duration of the Preferred Stock is:

1. 4.9 years
2. 5.2 years
3. 9.8 years
4. 10.3 years
5. 14.7 years

4. Using the convexity formula given on the last page of the exam, [but on an annual basis rather than semi-annual because m = 1], the Convexity of the Preferred Stock is:

1. 81.2
2. 148.1
3. 162.7
4. 1162.3
5. 178.7

5. Suppose now the redeemable preferred has a redemption schedule requiring redemption of 1/15 of the original issue, or $5 million, at the end of years 11 through 25. It also specifies that the Trustee must randomly select the shares to be redeemed in each year. What is the expected term to redemption and rate of return with this redemption schedule?

1. 17 Years and 4.93%
2. 17 Years and 8.50%
3. 18 Years and 9.86%
4. 18 Years and 10.03%
5. 19 Years and 10.11%

6. The Duration of the Preferred Stock with the data given in question #5 [on an annual basis with m = 1], is now:

1. 4.2 years
2. 4.4 years
3. 4.6 years
4. 8.9 years
5. 9.3 years

7. The Convexity of the Preferred Stock with the data given in question #5 [on an annual basis with m = 1], is now:

1. 66.8
2. 110.4
3. 121.2
4. 121.5
5. 133.7

8. Assume now the redeemable preferred has a redemption schedule requiring redemption of redemption of $5 million of preferred shares at the end of years 16 through 24 and the balance of $30 million in year 25. What is the expected term to redemption and rate of return with this redemption schedule?

1. 21 years and 4.93%
2. 21 years and 9.86%
3. 22 years and 8.50%
4. 22 years and 9.92%
5. 23 years and 9.86%

9. The Duration of the Preferred Stock with the data given in question #8 [on an annual basis with m = 1], is:

1. 5.0 years
2. 9.1 years
3. 9.5 years
4. 10.0 years
5. 10.4 years

10. The Convexity of the Preferred Stock with the data given in question #8 [on an annual basis with m = 1], is:

1. 73.2
2. 133.5
3. 146.4
4. 146.7
5. 161.3

11. As an alternative to having the Trustee randomly select the shares to be redeemed, suppose the issuer is permitted to purchase preferred shares on the open market in order to fulfill its obligation to redeem shares. Specifically, the company can buy the shares at the market price and present them for cancellation rather than pay the Trustee $40 per share for the shares to be redeemed. Which of the following statements is most correct?

1. The issuer would exercise this Delivery Option when the price is less than $40.
2. The issuer would exercise this Delivery Option when the price is greater than $40.
3. The issuer would exercise this Acceleration Option when the price is less than $40.
4. The issuer would exercise this Acceleration Option when the price is greater than $40.
5. The issuer would most likely never exercise this Delivery Option unless the price is less than $25.

12. Assume the year 16 redemption is only one week away and the issuer has not purchased any shares in the open market. What factors might cause the circumstance described in question #11 to occur?

1. Interest rates have increased since the preferred was issued.
2. Interest rates have decreased since the preferred was issued.
3. The shares are held by a small number of institutional investors.
4. Both answers a. and c. could be a cause.
5. None of the above factors could be a cause.

13. If the issuer buys shares in the market and is able to submit them to the Trustee at the next redemption is lieu of cash, what effect this will have on the expected rate of return for investors?

1. The expected rate of return will be reduced.
2. The expected rate of return will be increased.
3. The expected rate of return will be unchanged.
4. All of the above answers are correct.
5. None of the above answers are correct.

14. Assume time has passed and it is now the beginning of year 15 [year 14 obligations have just been paid]. The preferred trades for $42. Using the Redemption schedule from question #5, [the redemption schedule requiring redemption of 1/15 of the original issue, or $5 million, at the end of years 11 through 25] what is the expected rate of return on the shares. Assume the issuer has met the redemption obligations for years 11 through 14 and the issuer does not hold any shares purchased in the open market. Shares to be redeemed in future years will be randomly selected.

1. 7.44%
2. 8.03%
3. 8.50%
4. 9.86%
5. 14.87%

15. The Duration of the Preferred Stock with the data given in question #14 [on an annual basis with m = 1], is:

1. 2.4 years
2. 2.5 years
3. 4.6 years
4. 4.8 years
5. 5.0 years

16. The Convexity of the Preferred Stock with the data given in question #14 [on an annual basis with m = 1], is:

1. 15.1
2. 28.1
3. 30.2
4. 32.5
5. 34.7

17. Assume time has passed and it is now the beginning of year 15 [year 14 dividends have just been paid]. The preferred trades for $42. Using the Redemption schedule from question #8, [the redemption schedule requires redemption of $5 million of preferred shares at the end of years 16 through 24 and the balance of $30 million in year 25] what is the best estimate of the expected rate of return on the shares. Assume the issuer does not hold any shares purchased in the open market. Shares to be redeemed in future years will be randomly selected.

1. 7.64%
2. 8.03%
3. 8.50%
4. 10.03%
5. 15.28%

18. The Duration of the Preferred Stock with the data given in question #17 [on an annual basis with m = 1], is:

1. 3.0 years
2. 5.7 years
3. 5.9 years
4. 6.0 years
5. 6.2 years

19. The Convexity of the Preferred Stock with the data given in question #17 [on an annual basis with m = 1], is:

1. 23.4
2. 43.5
3. 46.8
4. 50.4
5. 56.4