EMBA Financial EConomics exam -2016 Topic 3: Bonds and interest rates 1. Two Treasury bonds have face values of $100,000 and pay coupons at the rate of 10% p.a., semi-annually. Bond P has four years to maturity and bond Q has eight years to maturity. a) If the yield on the bonds is 7.5% p.a., what are the prices of the two bonds? b) If the yield rises to 12% p.a., what are the prices of the two bonds? c) What do the prices illustrate about the relations between price, yield, coupon rate and maturity? 2. On 27 January 2014, the Nasdaq OMX Riga website was showing that the 5-Year Latvian Government T-bond (paying an annual coupon rate of 4.375% on a face value of 100 EUR) was trading at 108.4021% of face value. The bond had just paid its annual coupon and had 3 years left until it matures on 27 January 2017. What yield was the bond offering an investor? 3. A bond of a firm in severe financial distress pays annual coupons with a coupon rate of 14%, has a face value of $1000, has 10 years to maturity, and sells for $900. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce the coupon payments on the bond to one-half of the originally contracted amount. The firm can handle these lower payments. What is the stated and expected yield to maturity on the bond? 4. You are given the following information about five government bonds with face value of 100: Bond Years to maturity Coupon payment Price (PV) A 1 7.0 100 B 2 8.0 102 C 3 6.7 95 D 4 7.0 93 E 5 12.0 109 a) Estimate the spot rates for the next five years. You may find the following formula useful (price of a bond in terms of cash flows and spot rates, rt): T T T r C r C r C r C PV 1( ) ... 1( ) 1( ) 1( ) 3 3 3 2 2 2 1 1 1 + + + + + + + + = b) Draw the term structure of the interest rates, with the spot rates on the y-axis and the time to maturity on the x-axis. c) Discuss the possible explanations for the shape of the term structure. Topic 4: Company valuation 1. Computer stocks currently trade at a required return on equity of 16%. Kr?slavas Kompji, a large computer company will pay a year-end dividend of $2 per share. a. If the stock is selling at $50 per share, what must be the market’s expectation of the growth rate of dividends? b. If dividend growth forecasts for Kr?slavas Kompji are revised downward to 5% per year, what will happen to the price of Kr?slavas Kompji stock? What (qualitatively) will happen to the company’s P/E ratio? 2. You believe that next year Br??u Corp. will have earnings per share equal to 6 on its common stock. Thereafter you expect earnings to grow at a rate of 8% p.a. in perpetuity. The payout ratio is 1/3. You require a return of 12% on your investment. a. How much should you be prepared to pay for the stock? b. Compute the return on equity (ROE) and present value of growth opportunities (PVGO). c. Assume that ROE has changed to 10%. How much should you be prepared to pay for the stock? Compute PVGO. How could management change the payout policy to increase the value of the company? d. Assume that ROE has changed to 15%. How much should you be prepared to pay for the stock? Compute PVGO. How could management change the payout policy to increase the value of the company? 3. Which of the following companies would expect to distribute a relatively high or low proportion of current earnings, explain your answer: a. High-risk companies b. Companies that have experienced an unexpected decline in profits c. Companies that expect a decline in profits d. Growth companies with valuable future investment opportunities 4. A manufacturing firm with no debt outstanding and a market value of $100 million is considering borrowing $40 million and buying back stock. The interest rate on debt is 9% and the firm faces a tax rate of 35%. a. Estimate the annual tax savings from the debt. b. Estimate the present value of the interest tax savings assuming the debt change is permanent. c. Estimate the present value of the interest tax savings assuming the debt will be taken on for 10 years only. d. What will happen to the present value of tax savings if interest rates drop tomorrow to 7% but the debt itself is fixed rate debt?
No comments:
Post a Comment