What is expected capital gains yield

Assignment Help Financial Management

Reference no: EM132019177

Airnova Inc. has two types of bonds, Bond D and Bond F. Both have 8 percent coupons, make semiannual payments, and are priced at par value. Bond D has 2 years to maturity. Bond F has 15 years to maturity.

Airnova Inc. is considering four different types of stocks. They each have a required return of 20 percent and a dividend of $3.75 for share. Stocks, A, B, and C are expected to maintain constant growth rates in dividends for the near future of 10 percent, 0 percent, and -5 percent, respectively. Stock D is a growth stock and will increase its dividend by 30 percent for the next four years and then maintain a constant 12 percent growth rate after that.

Discuss • If interest rates suddenly rise by 2 percent, what is the percentage change in both bonds? Since both of the bonds are sold at par, the yield to maturity is 8%, with a rate rise by 2%, it will yield to maturity at 10%. Bond D: FV=1000, PMT – 8% divided by 2 of 1000 = 40, rate = 10% divided by 2, N= 4, and the price of Bond D = 964.54. The percentage change in price = 964.54/1000-1 = -3.55% Bond F: FV=1000, PMT = 8%/2 of 1000 = 40, rate =10%/2, N=30, and the price of Bond F = 846.2755, % change in price = 846.2755/1000-1 = -15.37%

• If rates suddenly fall by 2 percent, what is the percentage change in both bonds? If the rates drop by 2%, yield to maturity =6%. Bond D: FV=1000, PMT = 8%/2 of 1000 = 40, rate = 6%/2, N=4, price of Bond D = 1037.1710, % change in price = 1027.1710/1000-1 = 3.72% Bond F: FV=1000, PMT = 6%/2 of 1000 = 40, rate = 10%/2, N = 30, price of Bond F = 846.2755, % change in price = 1196.0044/1000-1 = 19.60%

• What does this tell you about the interest rate risk of longer-term bonds? The longer the tenure of the bonds the higher is the sensitivity to interest rate risk. • What is the dividend yield for each of the four stocks? Dividend yield of A =20% - 10% = 10% Dividend yield of B = 20% - 0% = 20% Dividend yield of C = 20% - (-5%) = 25% Dividend yield of D = 20% - 30% = -10%.

Please answer the last two.

1. What is the expected capital gains yield?

2. Discuss the relationship among the various returns that you find for each of the stocks.

Reference no: EM132019177

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