2. What would be the initial offering price for the following bonds ( assume sem

Question

2. What would be the initial offering price for the following bonds ( assume semiannual compounding)?
a. A 15- year zero- coupon bond with a yield to maturity ( YTM) of 12 percent
b. A 20- year zero- coupon bond with a YTM of 10 percent

3. Why does the present value equation appear to be more useful for the bond investor than for the common stock investor?

4. What are the important assumptions made when you calculate the promised yield to maturity? What are the assumptions when calculating promised YTC?

Explanation / Answer

2.a. 1000/1.06^30=$174.11

b. 1000/1.05^40= $142.05

3.The present value equation is more useful for the bond investor largely because the bond investor has fewer uncertainties regarding future cash flows than does the common stock investor. By investing in bonds with relatively no default risk (i.e., government securities) the investor can value a bond based primarily on expected cash flows (coupon rate and par value), required return (market yield), and the number of periods in the investment horizon (maturity date). Each of these factors can be incorporated into the present value equation. By contrast, common stocks have no stated maturity date and the valuation process is predominantly an estimate of future earnings. Although the present value method can be used for common stock analysis by estimating dividend payments and change in price over a given time frame, the uncertainties involved are much greater.

4. The most crucial assumption the investor makes is that cash flows will be received in full and reinvested at the promised yield. This assumption is crucial because it is implicit in the mathematical equation that solves for promised yield. If the assumption is not valid, an alternative method must be used, or the calculations will yield invalid solutions.

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.