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210-211)

5.1 Bond Valuation with Annual Payments

Jackson Corporations bonds have 12 years remaining to maturity. Interest is paid annually, the bonds

have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%.

What is the current market price of these bonds?

$928.39 = PV (9%, 12, -80, -1000)

5.2 YTM for Annual Payments

Wilson Wonders bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a

$1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is their

yield to maturity?

12.48% = RATE (12, 100, -850, 1000)

5.6 Maturity Risk Premium

The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury

security yields 6.3%. What is the maturity risk premium for the 2-year security?

R = R* + IP + DRP + LP + MRP

6.3% = 3% + 3% + 0% + 0% + MRP

6.3% - 6% = MRP

0.3% = MRP

5.7 Bond Valuation with Semiannual payments

Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature

in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?

$1,085.80 = PV (8.5%/2, 8*2, -100/2, -1000)

5.13 Yield to Maturity and Current Yield

You just purchased a bond that matures in 5 years. The bond has a face value of $1,000 and has an 8%

annual coupon. The bond has a current yield of 8.21%. What is the bonds yield to maturity?

Current yield = payments/ Bond price

8.21% = $80 / Bond price

8.21% * (Bond price) = $80

Bond price = $974.42

YTM = 8.65% =RATE (5, 80, -974.42, 1000)

Questions (p.257)

6.6 Beta and expected return

If a companys beta were to double, would its expected return double?

If a companys beta were to double the expected return would not double. The result of doubling a

companys beta would impact its correlation to the market. If the company had a beta between 0 and 0.5

doubling the beta would make the company behave more like the market. If a company had a beta

greater 0.5 before being doubled it would begin to react more drastically to market changes, and if a

company had a negative beta it would begin to act more unlike the general market.

Problems (pp. 258-259)

6.1 Portfolio Beta

An individual has $35,000 invested in a stock with a beta of 0.8 and another $40,000 invested in a stock

with a beta of 1.4. If these are the only two investments in her portfolio, what is her portfolios beta?

Beta = 1.12 = (($35,000*0.8) + ($40,000*1.4)) / ($35,000 + $40,000)

6.2 Required Rate of Return Stock

Assume that the risk-free rate is 6% and that the expected return on the market is 13%. What is the

required rate of return on a stock that has a beta of 0.7?

Risk premium of market = RP = R R

RP = 13% - 6%

RP = 7%

Risk premium for stock = RP = (RP)b

RP = (7%) * 0.7

RP = 4.9%

Required rate of return = risk-free rate + RP

= 6% + 4.9%

= 10.9%

6.7 Required Rate of Return

Suppose rRF = 9%, rM = 14%, and bI = 1.3.

a. What is rI, the required rate of return on Stock I?

RP of market = RP = R -R

RP of market = 14% - 9%

RP = 5%

RP of stock = RP = (RP)b

RP of stock = (5%) * 1.3

RP = 6.5%

Required rate of return = risk-free rate + RP

Required rate of return = 9% + 6.5%

= 15.5%

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?

With an increase or decrease in the risk free rate and a constant slope the SML line would remain

parallel in scenario (0), (1), and (2) with scenario (0) in between the other two lines on a plotted

graph. The affect this would have on the rate of return on the market and stock is in (1) a 1%

increase, and in (2) a 1% decrease.

c.

Now assume rRF remains 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?

When the risk free rate remains constant and the expected rate of return on the market (1)

increases to 16% the RP of the market would also increase to 7%, the RP of the stock to 9.1%,

and the required rate of return for the stock to 18.1%. With this given the slope of the equation

would increase by 2% from 5%, creating a more aggressive potential for return on investment.

(2) The opposite would occur if the expected rate of return on the market would decrease to 13%.

The RP of the market would decrease to 4%, the RP of the stock to 5.2% and the required rate of

return for the stock to 14.2%. The slope of the equation would decrease by 1% from 5%, creating

a more conservative market and potential for returns on the stock.

(0), (1), and (2) would no longer be parallel as in question b. and would intersect.

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