FINE 6050 - Exam 1 & 2 - Study Guide

1.) BOND & STOCK VALUATION Example 1: What is the price of a $1,000 par, pure discount bond having six years left to maturity, and whose YTM is 8.25%? Which Formula to Use? PV= F (1+rt ) t How to Work the Problem: PV = $1,000/(1+.0825)6  PV = $621..50 Question 1: How do you calculate the Pure Discount Bond’s Yield to Maturity? Answer 1-e? Can be derived from PV= F (1+rt ) t  (1+rt ) t= F PV  F PV ¿ ¿ (¿ 1 T ¿)−1 rt=¿ Example 2: The December 21, 1993, Wall Street Journal reports a one year, $10,000 par Treasury Bill ‐ sells for $9,654.38. Find this T Bill’s YTM? ‐ Which Formula to Use? YTM = rT = “Spot Rate”  YTMT = [(F/PV)^(1/T)] -1 How to Work the Problem: YTM = [($10,000/$9654.38)^1] 1= 3.58% ‐ Example 3: Find the term structure for these bonds: t PV YTM, rt 1 94.0 6.38% 2 89.50 5.70% 3 85.25 5.46% 4 81.25 5.33% For Example  rT= (100/85.25)1/3–1 = 5.46% Question 2: What sort of bond makes periodic coupon payments, usually twice annually, and returns the par value at maturity? Answer: The Level-Coupon Bond. Questions 3: What is the price of a Level-Coupon Bond? Answer 3: PV= C (1+r1 ) 1 + C (1+r2 ) 2 +…+ C (1+rT ) T + F (1+rT ) T Example 3 (cont.): Find the price of three year, 8% coupon bond, given the following yield curve, ‐ t rT 1 6.38% 2 5.70% 3 5.46% 4 5.33% NOTE: C = $0.08 X $1000 = $80 Answer: PV = 80 (1+0.0638) 1 + 80 (1+0.0570) 2 + 80 (1+0.0546) 3 + $ 1000 (1+0.0546) 3 Question 4: What rate for a bond makes the Present Value of its coupons and principle income equal to the bond’s price? Answer 4: Coupon Bond’s Yield to Maturity Example 4: Find the YTM for a three year, 8% coupon bond, given the yield curve: t rT 1 6.38% 2 5.70% 3 5.46% 4 5.33% Given the Yield Curve, the bond’s price is $1,067.60. Thus the YTM is found from: $ 1,067.60= $ 80 (1+ y3 ) 1 + $ 80 (1+ y3 ) 2 + $ 80 (1+ y3 ) 3 + $1,000 (1+ y3 ) 3 Answer 4-e: So y3 = 5.495% Question 5: What security is an equity instrument issued by a corporation that has “residual” claim on earnings and assets? Answer 5: Common Stock Question 6: Who owns the firm