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  1. You are on your lunch break at work and you hear colleagues talking about bonds. Lexi said, “When a company issues a bond, the buyer of that bond becomes, in effect, a part owner of the company.” Lauren says, “Bonds are really only bought by banks. So, in a weird way, the source and the use of the funds is the same.” Madeleine says, “When an investor buys a bond, the investor is giving money to the issuer of that bond – with the assurance that it will be repaid at a future date.” You are asked to comment on what you hear – who is correct? Is it Lexi, Lauren, Madeleine or some combination of them? Indicate who is correct and why and who is incorrect and why.
  1. The discussion continues. “I am interested in buying a zero coupon bonds. You can only make money on these if you know what you are doing. These are bought at face value and sold at a premium at a later date,” said Lexi. Lauren said, “what are you talking about? Zero coupons pay amazing regular interest payments – that’s why you buy them.” Madeleine put in her view “look, you buy bonds because they always increase in value over time.” Wally overheard and said, “zero coupons are bought because they tend to be purchased at a premium over their face value – and that is compelling.” Who is right – and why? Assess each statement and add your own if needed.

  1. Wally saw his friend Ollie enter the room and wanted to impress him. “Did you know, Ollie, that the feature of a bond where the issuer can redeem the bond from the holder in exchange for the face amount plus, in most cases, a premium is called a ‘sinking fund’ provision”. Ollie said, “what are you talking about! That is called a repo provision!” What do you think? Who is right – Wally or Ollie? Or, are they both right? Or, are both of them wrong? If both of them are wrong, what is it that Wally and Ollie are describing?
  1. Ollie said to Wally, “Well, if you are so smart than answer me this – is the yield of bonds with credit risk higher than that of otherwise identical default-free bonds? If so, why? If not, why not?”.
  1. Your lunch break is done – and you know need to return to your desk. Your boss has given you an assignment. The table below shows various bond prices at different maturity levels for zero coupon bonds. Based on this information, how would you describe the shape of the yield curve – is it: flat, upward sloping, downward sloping, generally flat or is there is not enough information present to make a determination? What does this shape mean? Note that the bonds all have $1,000 face value.

maturity

price

1

950.24

2

900.70

3

860.38

4

820.27

  1. Your boss is pleased – and your reward is more work. He asks you go address this question – the current yields for zero-coupon bonds with varying maturities are outlined in the table below. What is the forward rate from the end of year 2 to the end of Year 3? What does this rate denote?

Maturity

(Years)

Yield

1

2.75%

2

3.25%

3

3.65%

4

4.00%

5

4.15%

  1. Your boss indicates that he may be purchasing bonds as an investment. He asks you to comment: Firm A issues ten-year bonds with a coupon rate of 6.5%, paid semi-annually. The credit spread for this firm’s ten-year debt is 0.8%. New ten-year Treasury notes are being issued at par with a coupon rate of 5%. What should the price of the firm’s outstanding ten-year bonds be per $100 of face value?

Part B: Stock Markets and Share Pricing

  1. Your boss is very pleased with your work – and asks for your help in getting the values of some shares he is considering purchasing as investments for the company. TimCo Inc. shares are trading for $500. Analysts expect the company to generate net income of $41.7 billion. TimCo has 900 million shares outstanding. The average P/E ratio of TimCo’s competitors is 1 What is the fair price for a share of TimCo?

  1. Oscar Airlines has 115 million shares outstanding and expects earnings at the end of this year of $370 million. Oscar Air plans to pay out 40% of its earnings as a dividend and 20% of its earnings through share repurchases. The firm has an equity cost of capital of 8%. If Oscar Air’s earnings are expected to grow by 3% per year and these payout rates remain constant, what is the firm’s share price?
  1. Assume that the industry average market-to-book ratio for the car industry is 3. Estimate the fair value of Madi Corp based on the industry average multiple and the data supplied below.

Data: Shares outstanding: 487,000,000; Equity: $9,087,000,000; Price: $75; Debt: $445,000,000

  1. You are an investor considering the purchase of shares in Nanamobiles, a maker of specialty scooters. Shares of Nanmobiles are trading for $75 and its book value per share is $26.00. You have collected market-to-book information on Nanamobiles’ main competitors; this is in the table below. What is the fair value of Nanamobile shares and should you buy them?

M/B

Grandpa Motors

3.5

Pops’ Scooter

2.4

Retired Roadmasters

3.0

Old Dog Enterprises

4.9

  1. “All equity markets are efficient,” Sarah said. “I disagree,” said Chloe. “Large cap-markets are efficient – but small-cap markets are not,” she continued. Olivia went further. “What about developing country markets. I think these are not efficient.” What do you think? Is Sarah, Chloe or Olivia right? Or, are none of them right? Take a position and support it.

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