BOND VALUATION

An investor has two bonds in her portfolio, Bond C and Bond Z. Each bond matures in 4 years, has a face value of $1,000, and has a yield to maturity of 9.6%. Bond C pays a 10% annual coupon, while Bond Z is a zero coupon bond.

1. Assuming that the yield to maturity of each bond remains at 9.6% over the next 4 years, calculate the price of the bonds at each of the following years to maturity:
   Years to Maturity Price of Bond C Price of Bond Z
   4 _
   3
   2
   1
   0 _
2. Explain what you see from the pricing calculations. How do the two bonds differ?
   YIELD TO MATURITY AND YIELD TO CALL Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,175. The bonds may be called in 5 years at 109% of face value (Call price = $1,090).
3. What is the yield to maturity?
4. What is the yield to call if they are called in 5 years?
5. Which yield might investors expect to earn on these bonds? Why?

CAPM AND REQUIRED RETURN Bradford Manufacturing Company has a beta of 1.45, while Farley Industries has a beta of 0.85. The required return on an index fund that holds the entire stock market is 12.0%. The risk-free rate of interest is 5%. By how much does Bradford’s required return exceed Farley’s required return?
CAPM AND REQUIRED RETURN Calculate the required rate of return for Manning Enterprises assuming that investors expect a 3.5% rate of inflation in the future. The real risk-free rate is 2.5%, and the market risk premium is 6.5%. Manning has a beta of 1.7, and its realized rate of return has averaged 13.5% over the past 5 years.
CONSTANT GROWTH VALUATION Thomas Brothers is expected to pay a $0.50 per share dividend at the end of the year (that is, D1 = $0.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the stock’s current value per share?
NONCONSTANT GROWTH VALUATION Hart Enterprises recently paid a dividend, D0, of $1.25. It expects to have nonconstant growth of 20% for 2 years followed by a constant rate of 5% thereafter. The firm’s required return is 10%.

1. How far away is the horizon date?
2. What is the firm’s horizon, or continuing, value?
3. What is the firm’s intrinsic value today, ˆP0?

Sample Solution