The Five Unit VI Concept Questions

Instructions: In a WORD document, answer these five questions in such a way that you make it crystal clear you understand the issue at hand.

1.

"Not surprisingly, the higher the interest rate that investors demand, the less that they will be prepared to pay for the bond. Some bonds are more affected than others by a change in the interest rate. The effect is greatest when the cash flows on the bond last for many years. The effect is trivial if the bond matures tomorrow." Brealey, Myers, Allen, Principles of Corporate Finance, McGraw-Hill Irwin, 1st ed. 2006, p. 59]. Why is this so? Explain how, all else equal, it is intuitive that longer term bonds are more affected by interest rate changes than bonds closer to maturity. What about a low coupon bond compared to a high coupon bond? Would one or the other be more sensitive to interest rate changes? Why, or why not?

2.

Why does the value of a share of stock depend on dividends? A substantial percentage of the companies list on the NYSE and the NASDAQ dont pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible given your answer to the first part of Question 2, or is it?

3.

In the context of the DCF or dividend growth model, is it true that the growth rate in dividends and the growth rate in the price of the stock are identical? Explain/justify why it is or is not true.

4.

Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits.

5.

Can the cost of equity ever be lower than the cost of debt for any firm at any stage in its life cycle? Yes or no. If yes, explain the circumstances. If no, why?

Dr. PK Coats

Unit VI Assignment

FIN5425

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