Be sure to show all work and/or use Excel formulas to demonstrate how you arrived at your answer.

Questions

5-1

• Define each of the following terms:

a. Bond; Treasury bond; corporate bond; municipal bond; foreign bond

b. Par value; maturity date; coupon payment; coupon interest rate

c. Floating-rate bond; zero coupon bond; original issue discount bond (OID)

d. Call provision; redeemable bond; sinking fund

e. Convertible bond; warrant; income bond; indexed bond (also called a purchasing power bond)

f. Premium bond; discount bond

g. Current yield (on a bond); yield to maturity (YTM); yield to call (YTC)

h. Indentures; mortgage bond; debenture; subordinated debenture

i. Development bond; municipal bond insurance; junk bond; investment-grade bond

j. Real risk-free rate of interest, r∗r*; nominal risk-free rate of interest, rRFrRF

k. Inflation premium (IP); default risk premium (DRP); liquidity; liquidity premium (LP)

l. Interest rate risk; maturity risk premium (MRP); reinvestment rate risk

m. Term structure of interest rates; yield curve

n. “Normal” yield curve; inverted (“abnormal”) yield curve

(5-2) “Short-term interest rates are more volatile than long-term interest rates, so short-term bond prices are more sensitive to interest rate changes than are long-term bond prices.” Is this statement true or false? Explain.

(5-6). Maturity Risk Premium The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury security yields 6.3%. What is the maturity risk premium for the 2-year security? Intermediate Problems 7–20

(5-7). Bond Valuation with Semiannual Payments Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?

5-13). Yield to Maturity and Current Yield

• You just purchased a bond that matures in 5 years. The bond has a face value of $1,000 and has an 8% annual coupon. The bond has a current yield of 8.21%. What is the bond’s yield to maturity?

(7-2). Constant Growth Valuation Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1=$1.50D1=$1.50). The dividend is expected to grow at a constant rate of 6% a year. The required rate of return on the stock, rsrs, is 13%. What is the estimated value per share of Boehm’s stock?

(7-4). Preferred Stock Valuation

• Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return (assume the market is in equilibrium with the required return equal to the expected return)?

(7-5). Nonconstant Growth Valuation

• A company currently pays a dividend of $2 per share (D0=$2)(D0=$2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?