CHAPTER 6.
SECURITIES VALUATION
I. Multiple choice
1. The market currently demands a 15% return on ABC Company's 20-year bonds.
What is this 15% referred to as?
A. Coupon rate
B. Coupon
C. Interest
D. Yield to maturity
2. A 5-year bond with a face value of $1,000 currently sells for $1050. Which of the
following statements is correct?
A. The bond’s current yield is equal to its coupon rate.
B. The bond’s coupon rate less than its current yield.
C. The bond’s coupon rate is greater than its YTM.
D. If the yield to maturity stays constant until maturity, the bond’s price will remain at
$1050.
3. M Company offers 7% coupon bonds with annual payments and a yield to
maturity (YTM) of 8%. The bonds mature in 4 years. What is the market price
per bond if the face value is $1,000?
A. $891.47
B. $974.23
C. $966.88
D. $1191.47
P = (x =1->4) 70/(1+8%)^x + 1,000/(1+8%)^4 = 966.88
4. Staind, Inc., has 7.5 percent coupon bonds on the market that have 10 years left
to maturity. The bonds make annual payments. If the YTM on these bonds is 8.75
percent, what is the current bond price?
A. $891.47
B. $918.89
C. $966.88
D. $1191.47
P = (x =1->10) [7.5%x1,0000/(1+8.75%)^x] + 1,000/(1+8.75%)^10 = 918.89
5. Grohl Co. issued 11-year bonds a year ago at a coupon rate of 6.9 percent. The
bonds make semiannual payments. If the YTM on these bonds is 7.4 percent, what
is the current bond price?
A. $891.47
B. $918.89
C. $965.10
D. $966.88
10 years left – semiannual periods => N = 10x2 = 20
Annual coupon rate = 6.9% => semiannual coupon payment = (6.9%/2) x 1,000 = 34.5
Semiannual YTM = 7.4%/2 = 3.7%
P = (x =1->20) [34.5/(1+3.7%)^x] + 1,000/(1+3.7%)^10 = 965.10
6. MNX stock price is $10 per share, and its expected year-end dividend is $1 per
share. The stock’s required return is 13%, and the dividend is expected to grow at
a constant rate forever. What is the dividend growth rate?
A. 2%
B. 3%
C. 4%
D. 5%
R = 13%
P0 = 10
D=1
Constant dividend growth
P0 = D/ (r – g) => g = r – D/P0 = 13% - 1/10 = 3%
II. SHORT ANSWER
1. Discuss this statement: “A bond’s yield to maturity is equal to the investor’s
expected rate of return?”
This statement is False.
The yield to maturity is the returns earned in the form of coupon interest
payments and the maturity value on its expiry. The summation of all these returns on a
bond equals its yield to maturity and it has nothing to do with the investors required rate
of return.
2. When should an investor buy perferred stocks or common stocks?
Preferred stock shareholders have priority over a company's income, meaning they
are paid dividends before common stock shareholders
3. The McKeegan Corporation has two different bonds currently outstanding.
• Bond M has a face value of $20,000 and matures in 20 years. The bond makes no
payments for the first six years, then pays $1,100 every six months over the
subsequent eight years, and finally pays $1,400 every six months over the last six
years.
• Bond N also has a face value of $20,000 and a maturity of 20 years; it makes no
coupon payments over the life of the bond.
If the required return on both these bonds is 7 percent compounded semiannually,
what is the current price of bond M? Of bond N?
- Bond M:
FV = 20,000
N = 20 -> semiannual = 40
YTM = 7% => semiannual YTM = 7/2 = 3.5%
P = (x=1->16) 1,100/(1+3.5%)^x + (x=1->12) 1,400/(1+3.5%)^x +
20,000/(1+3.5%)^40 = 31,883.65
- Bond N
FV = 20,000
N = 20
P = 20,000/(1+3.5%)^40 = 5,051.45
4. The Jackson–Timberlake Wardrobe Co. just paid a dividend of $1.95 per share
on its stock. The dividends are expected to grow at a constant rate of 6 percent per
year indefinitely.
• If investors require an 11 percent return on The Jackson–Timberlake Wardrobe
Co. stock, what is the current price?
• What will the price be in three years? In 15 years?
D = 1.95
g = 6%
r = 11%
Current price: P0 = D(1+g)/(r-g) = 1.95x(1+6%)/(11%-6%) = 41.34
Price in 3 years: P = (x=1->3) 1.95/(1+11%)^x + 41.34/(1+11%)^3 = 34.99
Price in 15 years: P = (x=1->15) 1.95/(1+11%)^x + 41.34/(1+11%)^15 = 22.66
5. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
on the stock over the next nine years because the firm needs to plow back its
earnings to fuel growth. The company will pay a $10 per share dividend in Year 10
and will increase the dividend by 5 percent per year thereafter. If the required
return on this stock is 14 percent, what is the current share price?
R=14%
Dividend in year 10: D10 = 10x(1+5%)^10 = 16.29
Dividend in year 11: D11 = D10x(1+5%)= 16.29x(1+5%) = 17.1
Dividend discount model:
P0 = D11/ (r-g) = 17.1/(14%-5%) = 190.04
Present value of share price: PV = P0/ (1+r)^n = 190.04/(1+14%)^10 = 51.26
6. E-Eyes.com Bank just issued some new preferred stock. The issue will pay a $20
annual dividend in perpetuity, beginning 20 years from now. If the market requires
a 6.4 percent return on this investment, how much does a share of preferred stock
cost today?
R = 6.4%
D = 20
P0 = D/r = 20/6.4% = 312.5
