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Ms. Delatorre mentioned that she purchased a stock one year ago for $250 per share, and that the stock has a current market value equal to $240. She knows she received a dividend payment equal to $25, but she doesn't know what rate of return she earned on her investment. Help Ms. Delatorre by showing her how to compute the rate of return on her investment. What do you call the price that a borrower must pay for debt capital? What is the price of equity capital? What are the four fundamental factors that affect the cost of money, or the general level of interest rates, in the economy? Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included when determining the interest rate on (1) short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities? Explain how the premiums would vary over time and among the different securities.

Ms. Delatorre mentioned that she purchased a stock one year ago for $250 per share, and that the stock has a current market value equal to $240. She knows she received a dividend payment equal to $25, but she doesn't know what rate of return she earned on her investment. Help Ms. Delatorre by showing her how to compute the rate of return on her investment. What do you call the price that a borrower must pay for debt capital? What is the price of equity capital? What are the four fundamental factors that affect the cost of money, or the general level of interest rates, in the economy? Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included when determining the interest rate on (1) short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities? Explain how the premiums would vary over time and among the different securities.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Robert Campbell and Carol Morris are senior vice-presidents of the Mutual of Chicago Insurance Company. They are co-directors of the company's pension fund management division, with Campbell having responsibility for fixed income securities (primarily bonds) and Morris being responsible for equity investments. A major new client, the California League of Cities, has requested that Mutual of Chicago present an investment seminar to the mayors of the represented cities. Campbell and Morris, who will make the actual presentation, have asked you to help them by answering the following questions. 6. What are the key features of a bond? 7. What is the value of a 1-year, $1,000 par value bond with a 10% annual coupon if its required rate of return is 10%? What is the value of a similar 10-year bond? 8. (1) What would be the value of the bond described in Q7 if, just after it had been issued, the expected inflation rate rose by three percentage points, causing investors to require a 13% return? Is the security now a discount bond or a premium bond? (2) What would happen to the bond's value if inflation fell, and re declined to 7%? Would it now be a premium bond or a discount bond? (3) What would happen to the value of the 10-year bond over time if the required rate of return remained at (i) 13% or (ii) remained at 7%? 9. (1) What is the yield to maturity on a 10-year, 9% annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between ra and the bond's coupon rate? (2) What is the current yield, the capital gains yield, and the total return in each case in the preceding question? 10. Suppose that the bond described in Q9 is callable in 5 years at a call price equal to $1,090. What is the yield to call (YTC) on the bond if its market value is $887? What is the YTC on the same bond if its current market price is $1,134.20? 11. What is interest rate price risk? Which bond in Q7 has more interest rate price risk, the one-year bond or the 10-year bond? 12. What is interest reinvestment rate risk? Which bond in Q7 has more interest rate reinvestment rate risk,
Transcribed Image Text:Robert Campbell and Carol Morris are senior vice-presidents of the Mutual of Chicago Insurance Company. They are co-directors of the company's pension fund management division, with Campbell having responsibility for fixed income securities (primarily bonds) and Morris being responsible for equity investments. A major new client, the California League of Cities, has requested that Mutual of Chicago present an investment seminar to the mayors of the represented cities. Campbell and Morris, who will make the actual presentation, have asked you to help them by answering the following questions. 6. What are the key features of a bond? 7. What is the value of a 1-year, $1,000 par value bond with a 10% annual coupon if its required rate of return is 10%? What is the value of a similar 10-year bond? 8. (1) What would be the value of the bond described in Q7 if, just after it had been issued, the expected inflation rate rose by three percentage points, causing investors to require a 13% return? Is the security now a discount bond or a premium bond? (2) What would happen to the bond's value if inflation fell, and re declined to 7%? Would it now be a premium bond or a discount bond? (3) What would happen to the value of the 10-year bond over time if the required rate of return remained at (i) 13% or (ii) remained at 7%? 9. (1) What is the yield to maturity on a 10-year, 9% annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between ra and the bond's coupon rate? (2) What is the current yield, the capital gains yield, and the total return in each case in the preceding question? 10. Suppose that the bond described in Q9 is callable in 5 years at a call price equal to $1,090. What is the yield to call (YTC) on the bond if its market value is $887? What is the YTC on the same bond if its current market price is $1,134.20? 11. What is interest rate price risk? Which bond in Q7 has more interest rate price risk, the one-year bond or the 10-year bond? 12. What is interest reinvestment rate risk? Which bond in Q7 has more interest rate reinvestment rate risk,
In an effort to better understand how her investments are affected by market factors, Michelle Delatorre, the professional tennis player introduced in Integrative Problem 3-2 in Chapter 3, has posed some questions about yields and interest rates that she wants answered. Your boss at Balik and Kiefer has asked you to answer the following questions for Ms. Delatorre. 1. Ms. Delatorre mentioned that she purchased a stock one year ago for $250 per share, and that the stock has a current market value equal to $240. She knows she received a dividend payment equal to $25, but she doesn't know what rate of return she earned on her investment. Help Ms. Delatorre by showing her how to compute the rate of return on her investment. 2. What do you call the price that a borrower must pay for debt capital? What is the price of equity capital? What are the four fundamental factors that affect the cost of money, or the general level of interest rates, in the economy? 3. Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included when determining the interest rate on (1) short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities? Explain how the premiums would vary over time and among the different securities. 4. What is the term structure of interest rates? What is a yield curve? At any given time, how would the yield curve facing a given company such as IBM or Microsoft compare with the yield curve for U.S. Treasury securities? Draw a graph to illustrate your answer. 5. Several theories have been advanced to explain the shape of the yield curve. The three major ones are the market segmentation theory, the liquidity preference theory, and the expectations theory. Briefly describe each of these theories. Do economists regard one as being "true"?
Transcribed Image Text:In an effort to better understand how her investments are affected by market factors, Michelle Delatorre, the professional tennis player introduced in Integrative Problem 3-2 in Chapter 3, has posed some questions about yields and interest rates that she wants answered. Your boss at Balik and Kiefer has asked you to answer the following questions for Ms. Delatorre. 1. Ms. Delatorre mentioned that she purchased a stock one year ago for $250 per share, and that the stock has a current market value equal to $240. She knows she received a dividend payment equal to $25, but she doesn't know what rate of return she earned on her investment. Help Ms. Delatorre by showing her how to compute the rate of return on her investment. 2. What do you call the price that a borrower must pay for debt capital? What is the price of equity capital? What are the four fundamental factors that affect the cost of money, or the general level of interest rates, in the economy? 3. Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included when determining the interest rate on (1) short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities? Explain how the premiums would vary over time and among the different securities. 4. What is the term structure of interest rates? What is a yield curve? At any given time, how would the yield curve facing a given company such as IBM or Microsoft compare with the yield curve for U.S. Treasury securities? Draw a graph to illustrate your answer. 5. Several theories have been advanced to explain the shape of the yield curve. The three major ones are the market segmentation theory, the liquidity preference theory, and the expectations theory. Briefly describe each of these theories. Do economists regard one as being "true"?
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