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FIN- Determinants of Interest Rates for Individual Securities




Question;6-1. Determinants of;Interest Rates for Individual Securities. A particular security?s default risk;premium is 2 percent. For all securities, the inflation risk premium is 1.75;percent and the real interest rate is 3.5 percent. The security?s liquidation risk;premium is 0.25 percent and maturity risk premium is 0.85 percent. The security;has no special covenants. Calculate the security?s equilibrium rate of return.;(LG6-4);6-2 Determinants of;Interest Rates for Individual Securities. You are considering an investment in;30 years bonds issued by Moore Corporation. The bonds have no special;covenants. The Wall Street Journal reports that 1-year T-bills are currently;earning 1.25 percent. Your broker has determined the following information;about economic activity and Moore Corporation Bonds;Real interest rate =;0.75%;Default risk premium =;1.15%;Liquidation risk;premium = 0.50%;Maturity risk premium;= 1.75%;a. What is the inflation;premium? (LG6-4);b. What is the fair;interest rate on Moore Corporation 30-year bonds? (LG6-4);6-5 Unbiased;Expectation Theory. Suppose that the current 1-year rate (1-year spot rate) and;expected 1-year T-bill rates over the following three years. (i.e., years 2, 3;and 4 respectively) are as follows;1R1 = 6%, E(2r1) = 7%;E(3r1) = 7.5%, E(4r1) = 7.85%;Using the unbiased;expectations theory, calculate the current (long-term rates) rates for 1-, 2-;3-, 4-year-maturity Treasury securities. Plot the resulting yield curve (LG6-5);6-7 Liquidity Premium;Hypothesis. One-year Treasury bills currently earn 3.45 percent. You expect;that one year from now, 1-year Treasury bill rates will increase to 3.65;percent. The liquidity premium on 2-year securities is 0.05 percent. If the;liquidity theory is correct, what should the current rate be on 2-year Treasury;securities? (LG6-5);6-15 Forecasting;Interest Rates. You note the following yield curve in The Wall Street Journal.;According to the unbiased expectation hypothesis, what is the 1-year forward;rate for the period beginning one year from today, 2f1? (LG6-6);Maturity Yield;One day 2.00%;One year 5.50;Two years 6.50;Three years 9.00;7-7. TIPS Interest and;Par Value. A 2 ? percent TIPS has an original reference CPI of 185.4. If the;current CPI is 210.7, what is the current interest payment and par value of the;TIPS? (LG7-2);7-9. Bond Quote.;Consider the following three bond quotes: a Treasury note quoted at 97.27, a;corporate bond quoted at 103.25, and a municipal bond quoted at 101.90. If the;Treasury and corporate bonds have a par value of $1,000 and the municipal bond;has a par value of $5,000, what is the price of these three bonds in dollars?;(LG7-3);7-13. Current Yield.;What?s the current yield of a 4.5 percent coupon corporate bond quoted at a;price of 102.08? (LG7-6);7-15. Taxable;Equivalent Yield. What?s the taxable equivalent yield on a municipal bond with;a yield to maturity of 3.5 percent for an investor in the 33 percent marginal;tax bracket? (LG7-6);7-21. Compute Bond;Price. Compute the price of a 4.5 percent coupon bond with 15 years left to;maturity and a market interest rate of 6.8 percent (Assume interest payments;are semiannual.) Is this a discount or premium bond? (LG7-4);8-15. Value of;Dividends and Future Price. A firm is expected to pay a dividend of $1.35 next;year and $1.50 the following year. Financial analysts believe the stock will be;at their price target of $75 in two years. Compute the value of this stock with;a required return of 11.5 percent. (LG8-5);8-19. Value a Constant;Growth Stock. Financial analysts forecast Safeco Corp.?s (SAF) growth rate for;the future to be 10 percent. Safeco?s recent dividend was $1.20. What is the;value of Safeco stock when the required return is 12 percent? (LG8-5);8-25. P/E Ratio Model;and Future Price. Kellogg Co. (K) recently earned a profit of $2.52 earnings;per share and has a P/E ratio of 19.86. The dividend has been growing at a 5;percent rate over the past few years. If this growth rate continues, what would;be the stock price in five years if the P/E ratio remained unchanged? What;would the price be if the P/E ratio declined to 15 in five years? (LG8-7);8-33. Variable Growth.;A fast growing firm recently paid a dividend of $0.35 per share. The dividend;is expected to increase at a 20 percent rate for the next three years.;Afterwards, a more stable 12 percent growth rate can be assumed. If a 13;percent discount rate is appropriate for this stock, what is its value? (LG-6);8-34. Variable Growth.;A fast growing firm recently paid a dividend of $0.40 per share. The dividend;is expected to increase at a 25 percent rate for the next four years.;Afterwards, a more stable 11 percent growth rate can be assumed. If a 12.5;percent discount rate is appropriate for this stock, what is its value? (LG-6)


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