Assignment #4

Reference: Bond/Stock Valuation, Risk & Return

1. Bond Pricing: Assume a bond has a par value of $1,000 and promises to pay a fixed
annual interest rate (Coupon) of 8% (to be paid semi-annually). (a) If bonds of similar
risk offer an annual rate of 9% (i.e. market rate or yield =9%), how much should you pay
for this bond? Assume the bond has a life of 20 years. (b) What will be your $ and %
return if you sell the bond after one year? (Hint: Compute the Price at time 1 with the
same information, except N=19) (c) Discuss how the market adjusts for increase in
perceived risk of a bond.
2. Stock Pricing: Given the following information for GE: Dividend = 1.24 cents;
R=13.5%; g = 6%;. (a) Estimate the stock price using: (i) zero growth of dividends
(ii) Constant growth of dividends. (b) Compare your estimates to current stock price
of GE and discuss the reasons for discrepancy. (c) Discuss why it is relatively harder
to value stocks compared to bonds.
3. Hostile Bids and Stock Prices
Comcast put in a bid for Disney on February 11, 2004. This offer was then withdrawn
after a few months. Comcast's offer for Disney shareholders involved offering 0.78
share of a Comcast class A share for each Disney share,
(a) At the time the offer was placed, Disney was trading for $24.08. What was the
premium (in %) being offered to shareholders of Disney (Comcast share was
trading at $33.93 at the time of the offer).
(b) If you were holding shares in Walt Disney, would you think that Disney made the
right choice in not accepting the offer? Justify your answer using most recent
prices of Comcast and Walt Disney
4. Risk and Return
Holding Period Return: You bought 100 shares for $25 each and sold it a year later for
$39. The company also paid a dividend of 25 cents per share during that period. Assume
transaction costs of $8 incurred in buying and selling the shares (a) What is your
historical return in (a) $ and (b) %? (b) Is this a good return? Assume tax on dividends of
30% and capital gain of 20%.
Expected Return Assume you buy a lottery ticket, which has the odds of one winner for
every 1,000 tickets sold; The ticket costs $10 and if you win, you receive $2,800. What is
the expected return from buying this lottery ticket? If the State sells 10,000 of these
tickets, what will be their profit (before any expenses)? (Hint: Slides 89-92, slide #29)
5. Risk Management Take an example to illustrate the 5 key steps of risk management