Question

Answer the following questions:

1. Coupon rates: Kiss the Sky Enterprises has bonds on the market making annual payments, with 13 years to maturity, and selling for $1045. At this price, the bonds yield 7.5 percent. What must the coupon rate be on the bonds?

2. Bond prices: Grohl Co. issued 11 year bonds a year ago at a coupon rate of 6.9 percent. The bonds make semiannual payments. If the YTM on these bonds is 7.4 percent, what is the current bond price?

3. Bond yields: N corp. issued 12 year bonds 2 years ago at a coupon rate of 8.4 percent. The bonds make semiannual payments. If these bonds currently sell for 105 percent of par value, what is the YTM?

4. Nominal and real returns: An investment offers a 14 percent total return over the coming year. Bill Bernanke thinks the total real return on this investment will be only 9 percent. What does Bill believe the inflation rate will be over the next year?

5. Stock valuation: Keenan Co. is expected to maintain a constant 5.2 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 6.3 percent, what is the required return on the company’s stock?

6. Nonconstant dividends:   Bread, Inc. has an odd dividend policy. The company just paid a dividend of $6 per share and has announced that it will increase the dividend by $4 per share for each of the next five years, and then never pay another dividend. If you require an 11 percent return on the company’s stock, how much will you pay for a share today?

7. Two-stage dividend growth model:   Thirsty Cactus corp. just paid a dividend of $1.25 per share. The dividends are expected to grow at 28 percent for the next eight years and then level off to a 6 percent growth rate indefinitely. If the required return is 13 percent, what is the price of the stock today?

Solution Preview

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1.

Let C = the coupon rate. Then the bond pricing equation is:
$1045 =
C($1000)/(1+.075)+ C($1000)/(1+.075)^2 + C($1000)/(1+.075)^3 + … C($1000)/(1+.075)^12
+ (C+1)($1000)/(1+.075)^13
For which I do not know of any algebraic solution.

However, there are two things to note:
1. If this were a multiple choice question, we would know that C > 7.5 = YTM because the bond is selling at a premium (P = $1045 > par = $1,000).
2. We can set this up as a present value problem in Excel and use “Goal Seek” to find C....

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