AFIN858 2017

Week 4 Q&Ps - Suggested Answers and

Solutions
CHAPTER 6

1
a It is an inverse relationship.
b The longer the time to maturity, the greater the change in bond values for a given
change in interest rates, all else being equal.
c The lower the coupon rate, the greater the change in bond values for a given change in
interest rates, all else being equal.

P0 = [0.17(1.06)]/(0.12 0.06) = $3.00

P4 = 3.00(1.06)4 = 3.79 or

P4 =0.17*1.065/(0.12 0.06) = 3.79

Bond B would have the larger price change because it has a longer maturity.

Bond A: Price = 9 PVIFA(4,11%) + 100/(1.11)4 = 9 3.1024 + 65.87 = $ 93.79

Bond B: Price = 9 PVIFA(8,11%) + 100/(1.11)8

= 9 5.1461 + 43.39 = $89.70
1
20

8 = 0.4(1 + g)/(0.12 g)

0.96 8g = 0.4 + 0.4g

0.56 = 8.4g

g = 0.066 or 6.67%

25

D1 = 0.20(1.25); D2 = $0.25(1.2); D3 = $0.30(1.15); D4 = $0345(1.1)

P4 = $0.3795(1.05)/(0.16 0.05) = $3.6225

P0 = 0.25/1.16 + 0.30/(1.16)2 + 0.345/(1.16)3 + (0.3795 +3.6225)/(1.16)4

= 0.216 + 0.223 + 0.221 + 2.210 = $2.87

26
2.79 = 0.25/(1 + r) + 0.30/(1 + r)2 + 0.345/(1 + r)3 + 0.3795/(1 + r)4 +
[0.3795(1.05)/(r 0.05)]/(1 + r)4

We know from Problem 25 that r is very close to 16% because it gave P0 = $2.87

At 16.2% P0 = $2.82
At 16.3% P0 = $2.79 so r is very close to 16.3%.
r = 16.3%

29

a P3 = 0.4(1.08)/(0.15 0.08) = $6.17

P0 = 0.2/(1.15) + 0.3/(1.15)2 + (0.4 + 6.17)/(1.15)3 = $4.72

b P1 = 0.3/(1.15) + (0.4 + 6.17)/(1.15)2 = $5.23
P2 = (0.4 + 6.17)/1.15 = $5.71

P3 = $6.17
2
 Year Dividend Yield Capital Gains Yield
c.
1 0.2/4.72 = 4.24% (5.23 4.72)/4.72 = 10.76%
2 0.3/5.23 = 5.74% (5.71 5.23)/5.23 = 9.26%
3 0.4/5.71 = 7.00% (6.17 5.71)/5.71 = 8.00%
4 0.4(1.08)/6.17 = 7.00% (6.17(1.08) 6.1)/6.17 =8.00%

There is a slight rounding difference in year 1 and 2 caused by the number of decimal

points used but the dividend yield and capital gains yield should always add to 15%.

Year 1 based on our numbers is 5.23 4.72/4.72 = 10.80

Year 2 based on our numbers is 5.71 5.23/5.23 = 9.18

31

Now we have supernormal growth for three years and then normal growth.

Dividend Discount Factor Present Value

D1 = 0.20 ( 1.20) = 0.24 0.8621 0.207

D2 = 0.20 ( 1.20)2= 0.288 0.7432 0.214

D3 = 0.20 ( 1.20)3= 0.3456 0.6407 0.221

0.642

P3 = D4/ (r g) = D3(1 + gN) / (r gN)

= 0.3456 1.04 / (0.16 0.04)

= 0.3594 / 0.04

= $2.9952

P0 = Present value dividends 1 to 3 + present value of P3

= 0.642 + 2.9952 / 1.163

= $2.56

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