Reference no: EM132758287

Question: Problem 1: General Motors is presently enjoying abnormally high growth because of a surge in the demand for their new generation of cars. The company expects earnings and dividends to grow at a rate of 15% for the next 3 years, after which there will very slow growth (g = 1%) in earnings and dividends. The company's last dividend, D0, was $3.50. GM's beta is 0.8, the market risk premium is 6%, and the risk-free rate is 4%. What is the current price of the common stock?

Problem 2: Cartwright Brothers' stock is currently selling for $40 a share. The stock's last dividend was $1.87. The dividend growth rate is expected to be a constant 7% per year, forever. The risk-free rate and market risk premium are each 4%. What is the stock's beta?

Problem 3: The beta coefficient for stock A is 0.6. The risk free rate is 6 percent and the rate of return in the market is 11 percent. The current price for stock A is $30 and the next expected dividend is $1.80, and the expected growth rate is 4 percent, is the stock in equilibrium (Would you buy the stock)? Explain your answer.

Problem 4: Currently, 6-year Treasury securities yield 6.8%, a 10-year Treasury securities yield 7.2%, and a 3-year Treasury yields 7.4% in the future. If the expectations theory is correct, what does the market expect will be the yield on 1-year Treasury securities nine years from today?

Problem 5: A bond was issued on January 1st, 2002. The bond has an 8 percent annual coupon and it will mature in 10 years, therefore the bond matures on December 31st, 2012. You bought the bond on January 1st, 2007. The bond has a call protection for the first 7 years, therefore the bond cannot be called until 2009, after which the bond can be called for a premium of 2 percent. Interest rates have steadily fallen recently due to looming recession. Therefore, the bond is selling at a premium of 5 percent at a current value of $1050. The face value of the bond is $1000.

What is the yield to maturity?

What is the yield to call if the bond is called as soon as it is possible?

Which return, yield to maturity or yield to call, do you think you as an investor would actually be earning? Explain your reasoning!

Problem 6: Due to a recession, expected inflation this year is only 3 percent. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3 percent. Assume that the expectation theory holds and the real risk free rate r* = 2%. If the yield on a 3 year Treasury bond equals the 1 year yield plus 2 percent, what inflation rate is expected after year 1? The MRP is zero for all bonds.

Problem 7: Kennedy Gas Works has 10-year, $1,000 face value bonds that pay a 9% annual coupon. The bonds may be called in five years. The bonds have a nominal yield to maturity of 8% and a yield to call of 7.5%. What is the bond's call price?

Problem 8: In looking at the premium of options one will notice that the premium declines as the price of the option increases. Why does this happen?

Problem 9: When would an investor construct a long straddle? What kind of market conditions is the investor expecting to happen? What is the difference between a straddle and a strangle? (Hint: think BHP example from class)

Problem 10: You want to construct a bull spread with call options. You buy a call option with a strike of 105 and a premium of 7.00 and you sell a call for 110 with a premium of 4.70. When do you break even? What is your maximum gain at what price(s)? What is your maximum loss at what price(s)? Please draw a contingency graph to show graphically the outcome at different stock price levels.