Strategic Financial Management 5 & 6

5-10

The Brownstone Corporation’s bonds have 5 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 9%.

a.   

What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?

b.   

Would you pay $829 for one of those bonds if you thought that the appropriate rate of interest was 12%-that is, if  r d = 12%? Explain your answer.

 

5-21

Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1, 000 par value, a 10% coupon rate, and semiannual interest payments.

 

a.    Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%. At what price would the bonds sell?

b.    Suppose that, 2 years after the initial offering, the going interest rate had risen to 12%. At what price would the bonds sell?

c.   

Suppose, as in part a, that interest rates fell to 6% 2 years after the issue date. Suppose further that the interest rate remained at 6% for the next 8 years. What would happen to the price of the bonds over time?

 

6-7

Suppose rRF= 9%, r m = 14%, and bi = 1.3

 

a.    What is ri, the required rate of return on

Stock

i?

b.    Now suppose rRF (1) increases to 10% or (2) decreases to 8 %. The slope of the SML remains constant. How would this affect rM and ri?

c.    Now assume rRFremains at 9% but rm (1) increases to 16% or (2) falls to 13%. The slope of the SML does not remain constant. How would these changes affect ri?

       

6-9

Suppose you manage a $4 million fund that consists of four stocks with the following investments:

  

Stock

A

B

C

D

Investment	Beta
$4000,000	1.50
600,000	-0.50
1,000,000	1.25
2,000,000	0.75

 

If the market’s required rate of return is 14% and the risk-free rate is 6%, what is the fund’s required rate of return.