Question

1) IBM has outstanding bonds with 8% annual coupon rate, that pays interest semiannually. Par value of these bonds are $1,000 and they were issued 7 years ago, at the time, with a 30-year maturity (remember that N is the time-to-maturity).

a) If similar bonds have 9% return, how much would you be willing to pay for this bond?

b) If the bond is currently selling for $950, what would your annual Yield-to-Maturity be if you were to buy it at this price?

2) A company that you are interested in has an ROE of 20%. Its dividend payout ratio is 60%. The last dividend, that was just paid, was $2.00 and the dividends are expected to grow at the same current rate indefinitely. Company's stock has a beta of 1.8, risk-free rate is 5%, and the market risk premium is 10%.

a) Calculate the expected growth rate of dividends using the ROE and the retention ratio.

b) Calculate investors' required rate of return according to CAPM. c) Based on your estimations above, how much would you be willing to pay for this stock?

Answer 1

1) Given,

Par value = $ 1000

Annual coupon rate = 8%

Semi annual coupon rate = 8%/2 = 4%

Coupon payment (C) = $ 1000 x 4% = $ 40

Time to maturity = 30 years - 7 years = 23 years

Solution :-