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Part I: Sensitivity of Bond Price With Respect to YTM, Coupon Rate, and Maturity

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you have a bond with these features:

Coupon rate: 10% annual

Coupon payment frequency: semiannual

Time to maturity: 20 years

Face value: \$1,000

Yield to maturity (YTM, I, or r): 12%

Tabulate and graph the price of this bond by changing (one at a time):

Coupon rate from 1% to 30% (jumps of 1%)

Coupon payment frequency (# of compoundings) from once a year (annual bond) to 365 times a year

Time to maturity from 1 year to 50 years (in jumps of 1 year) Yield to maturity from 0% to 50%

Explain in words the relationship between price and each of the above parameters. Explain like a graduate student, not as a child.

Part 2: Stock Valuation

Use the CAPM formula to find the cost of common stock for the firm that you choose for Week 1 Discussion.

Get the beta for your firm from Yahoo Finance. Use a market risk premium of 6.5%

Get the risk free rate from Yahoo Finance (under Bonds, look for the longest-maturity Treasury Bond yield).

Calculate last year’s actual return for this firm using historical prices from Yahoo Finance. Choose your price from the Adj. Return column which adjusts the price for stock splits, dividends, and a whole bunch of things that otherwise cause you a lot of problems.

Consider the year to be End of August 2013 to End of August 2014

Annual historical return = (year-end price 2014 – price one year ago)/ price one year ago

In other words, calculate the percentage change in price during the last one year.

Imagine for the sake of this assignment that the required rate of return a year ago was the same as the one you calculated today using CAPM.

Compare your calculated historical return with the required rate of return you calculated using CAPM. Explain the difference. What would this difference indicate to the investors? What would they be tempted to do? Can this difference stay this way in the long-run?

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