Question

Q1

Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,120.

1. How much the bond is priced? (5 points)
2. What is the bond’s nominal yield to call? (5 points)

Q2:

Your uncle Sam asks for your advice on the comparison of the two following bonds:

Bond A: a 10-year, 10% annual coupon bond

Bond B: a 10-year, 10% semiannual coupon bond

Please answer the following questions and briefly provide your reasonings.

1. If all else equal, which bond you would prefer to buy and why? (3 points)
2. If the proper price for this semiannual bond is $1,000, what would be the proper price for the annual coupon bond? (5 points)

Q3:

Rebello's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return? (3 points)

Q4:

Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value? (12 points)

Year	0	1	2	3	4	5	6
Growth rate	NA	NA	NA	NA	50.00%	25.00%	8.00%
Dividends	$0.00	$0.00	$0.00	$0.25	$0.38	$0.47	$0.51

Q5:

ABC corporation suffers a declining of performance recently and shareholders are concerned that the executives might not do their best to run the company. Therefore, the company consults its board directors and people put up the following suggestions for consideration:

• Increase the percentage of executive compensation that comes in the form of cash and reduce the percentage coming from long-term stock options as managers prefer stable payment.
• Consider to issue shares to institutional investors such as mutual funds, pension funds, and hedge funds to increase the institutional ownership from 30% to 60%.
• Consider to hire more independent directors to sit on board.
• Change the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period.
• To grant the company’s outside auditing firm a lucrative year-by-year consulting contract with the company.

Please go through each suggestion and briefly state your thoughts on how the suggestion could possibly solve the conflicts between shareholders and the executives, and conclude your recommendations to the shareholders of ABC corporation. (12 points)

Answer 1

Answer to Q1 is as follows:

Calculation of Current Bond Price:

Nper = 15*2 = 30 (Period)

FV = 1000 (Face value of bond)

Rate = 6.50%/2 (Semi-annual YTM)

PMT = 1000*8.25%*1/2 = 41.25 (Semi-annual interest payment)

PV = ? (Current bond price)

Current Bond Price = PV(Rate,Nper,PMT,FV) = PV(3.25%,30,41.25,1000) = $1166.09

Current Bond price = $1,166.09

Calculation of Nominal Yield to Call:

Nper = 6*2 = 12 (Period)

FV = 1120 (Face value of bond)

PMT = 1000*8.25%*1/2 = 41.25 (Semi-annual interest payment)

PV = 1166.09 (Current bond price)

Rate = ? (Nominal Yield to Call)

Nominal Yield to Call = Rate(Nper,PMT,PV,FV)*2 = Rate(12,41.25,-1166.09,1120)*2 = 6.53%

Nominal yield to call = 6.53%