Questions #7,8, and CFA problem at bottom of page.

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Problem Set 4 Due: Monday, Oct. 24. 12:00 pm 1) Assume that Ford has a 30 year, 6.5% coupon bond. Given Ford's recent troubles, your broker indicates that the yield-to-maturity of this bond should be 7.95%. Assume that coupon payments are annual. What should be the price of this bond? 2) Assume that 3M Corporation has a 15 year, 8% coupon bond and that its reported yield-tomaturity is 7.3%. Assume that coupon payments are semiannual (remember that if payments occur on a semiannual basis then the reported yield to maturity will actually be twice the semiannual yield). What is the price of this bond? 3) Disney Corp has a 7 year, 6.95% coupon bond that is currently selling for 978.65. Assume that coupon payments are annual. What is the yield-to-maturity of this bond? (USE excel) 7.35% use IRR on excel. 4) Hayworth Industries does not currently pay dividends; however, investors expect that in four years, the firm will pay its first dividend of $1.50 per share. From that point onwards, the dividend is expected be $2 annually forever. Assume that investors required rate of return is 13%. What should the price of Hayworth Industries be today? 5) Last year, IBM paid a dividend of $1.50 per share. Investors think that IBM's dividend will grow at 10% for the next four years. After that, the dividend will be constant at $4. What should be the price per share of IBM if the discount rate is 8%? Chapter 5 6. You are considering the choice between investing $50,000 in a conventional 1-year bank CD offering an interest rate of 5% and a 1-year \"Inflation Plus\" CD offering 1.5% per year plus the rate of inflation. a. Which is the safer investment? b. Which offers the higher expected return? c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? d. If we observe a risk-free nominal interest rate of 5% per year and a risk free real rate of 1.5% on inflation-indexed bonds, can we infer that the market expected rate of inflation is 3.5% per year? 7. Suppose your expectations regarding the stock price are as follows: State of the Market Probability Ending Price Boom 0.35 $140 Normal Growth 0.30 110 Recession 0.35 80 HPR(including dividends) 44.5% 14.0 -16.5 Compute the mean and standard deviation of the HPR on the stocks. 8. Derive the probability distribution of the 1-year HPR on a 30-year US treasury bond with an 8% coupon if it is currently selling at par and the probability distribution of its yield to maturity a year from now is as follows: State of the Economy Probability YTM Boom 0.20 11.0% Normal Growth 0.50 8.0 Recession 0.30 7.0 For simplicity, assume the entire 8% coupon is paid at the end of the year rather than every 6 months. CFA problems: 1. Given $100,000 to invest, what is the expected risk premium in dollars of investing in equities versus risk-free T-bill ( US Treasury bills) based on the following table: Action Invest in equities Invest in risk-free T-bill Probability 0.6 0.4 1.0 Expected outcome $50,000 -$30,000 $5,000