1. Suppose you’re given with the following information for some assets; a 12-year 3.6%-coupon bond of semi-annual coupon payment with face value as $1,000, a common stock of $3.20 expected dividend with 3.5% growth rate currently. Both bond and common stock are issued by Company M&M. Answer the following questions.
a) Suppose the yield to maturity (that is, the discount rate) for the bond is 10%, what is the present value of this coupon bond? Is it a discount bond? Why? What if the discount rate is 4%?
b) Suppose the bond is in fact, callable. That is, the firm may repurchase it with the call price as $918 and the bond is callable at the end of year 4, what is the yield to call for this bond if the current bond price is $759? (That is, the discount rate for the bond if you choose to be called. Use IRR function in EXCEL for this question).
c) Suppose the stock price is $22.32 per share right now, and assuming the capital market is efficient, what is the required rate of return for the stock? What are the assumptions you have for this present value model?
d) Suppose the dividend growth rate for the first 4 years is 2.5% and after 4th year it changes to g% from the beginning of 5th year and on. If the stock price right now is $20.25 per share, what is possible growth rate of dividends g from the 5th year and on if using the rate of return obtained from c)?
e) Suppose the bond is convertible. That is, at the end of the 3rd year after issuance, the holder of the bond has the right to convert the bond with 1 to 5 ratio toward company M&M’s common stock. Would you possibly convert the bond at the end of 4th year if based on the above information in a) and c)?
f) Why the so-called “fair value” of financial asset is represented by the present value of future cash flows of financial asset?