Question

3. You have a 25 year semiannual bond that pays a 6 % coupon, you are happy with a 4 % yield. What will you pay for the bond? Is it a premium or a discount bond?

3A. A preferred stock pays a $3.20 dividend and investors want a 12 % return. If the growth rate on the companies common stock is 1 %, what are you willing to pay for the preferred stock?

Answer 1

3. Since it is a semi-annual bond, the coupon will be 3% and the semi-annual yield will be 2% per period. Hence, the present value equation will look like:

PV = 3/1.02 + 3/1.02^2 + ... + 3/1.02^50 + 100/1.02^50 = 131.4236.

Hence, $131.4236 is the amount we will be willing to pay for the bond.

Since the coupon is more than the yield, it is a premium bond. (Here we have assumed the face value of the bond to be 100.)

3A. The formula we will use will be the Dividend discount formula. It is given as:

Price = Div x (1+g)/(r-g) = 3.2 x 1.01/(0.12-0.01) = 29.381

Hence, we are willing to pay $29.381 or less.