Question

1. Consider the following bonds: Bond A matures in 20 years and pays a 9.0 percent annual coupon. Bond B matures in 10 years and pays a 9.0 percent annual coupon. The YTM on both bonds is 12.00 percent.

1. If the market required return on both bonds falls to 8 percent, which bond will realize the biggest dollar change in market value? Why?

2. What will be the market value of Bond A in 2 years, if the YTM stays constant?

2. Jones Brothers current dividend is $4.0 Six years ago, the company paid a $3.00 dividend. The company’s stock is priced to earn a 12.00% market required rate of return.

1. What is the current market value of a share of Jones Brothers common stock?

2. What will be the value of a share of Jones stock in 3 years, assuming the required return stays constant.

Answer 1

1)

a)

above image shows formulas(it is assumed that face value of bond is $1000)

Bond A realize the bigest dollar change because matutrity of bond A is longer

b)

after 2 years maturity = 18 years

everything remains same

price in 2 years = 782.51

2)

future value = present value(1+r)^n

4 = 3*(1+r)^n

where , r = constant growth rate

(1+r)^6 = 4 / 3

(1+r) = (1.333)^1/6

r = 4.912%

current market value = next year dividend(1+growth) / K - g

where K = cost of capital

g = growth

current market value = 4(1+4.912%) / (12% - 4.912%)

= $59.20

Stock price in 3 years = 4(1+4.912%)^4 / (12% - 4.912%)

= $68.36