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Fundamentals Of Financial Management 12th Edition Richard Bulliet, Eugene F Brigham, Brigham/Houston - Solutions

20 Name the major rating agencies and list some factors that affect bond ratings.
19 Differentiate between mortgage bonds and debentures.
18 What type of security can be used to minimize both interest rate and reinvestment rate risk for an investor with a fixed investment horizon?
17 To which type of risk are holders of long-term bonds more exposed? shortterm bondholders?
16 Differentiate between interest rate risk and reinvestment rate risk.
15 Hartwell Corporation’s bonds have a 20-year maturity, an 8% semiannual coupon, and a face value of $1,000. The going interest rate (rd) is 7% based on semiannual compounding. What is the bond’s price? ($1,106.78)
14 Describe how the annual payment bond valuation formula is changed to evaluate semiannual coupon bonds and write the revised formula.
13 Why do the prices of fixed-rate bonds fall if expectations for inflation rise?
12 Last year a firm issued 20-year, 8% annual coupon bonds at a par value of $1,000.(1) Suppose that one year later the going rate drops to 6%. What is the new price of the bonds assuming they now have 19 years to maturity? ($1,223.16)(2) Suppose that one year after issue, the going interest rate
11 What is meant by the terms new issue and seasoned issue?
10 The Henderson Company’s bonds currently sell for $1,275. They pay a $120 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,120. What are their YTM and their YTC, and which is “more relevant” in the sense that investors should expect to earn it?
9 Halley Enterprises’ bonds currently sell for $975. They have a 7-year maturity, an annual coupon of $90, and a par value of $1,000. What is their yield to maturity? (9.51%)
8 Explain the difference between yield to maturity and yield to call.
7 Which of those two bonds is a discount bond, and which is a premium bond?
6 A bond that matures in 12 years has a par value of $1,000 and an annual coupon of 10%; the market interest rate is 8%. What is its price? ($1,150.72)
5 A bond that matures in 8 years has a par value of $1,000 and an annual coupon payment of $70; its market interest rate is 9%. What is its price?($889.30)
4 In addition to default risk, what key risk do investors in foreign bonds face?
3 Why are U.S. Treasury bonds not completely riskless?
2 What are the four main issuers of bonds?
6-21 INTEREST RATE DETERMINATION Maria Juarez is a professional tennis player, and your firm manages her money. She has asked you to give her information about what determines the level of various interest rates. Your boss has prepared some questions for you to consider.a. What are the four most
6-20 INTEREST RATE DETERMINATION AND YIELD CURVESa. What effect would each of the following events likely have on the level of nominal interest rates?(1) Households dramatically increase their savings rate.(2) Corporations increase their demand for funds following an increase in investment
6-19 INFLATION AND INTEREST RATES In late 1980, the U.S. Commerce Department released new data showing inflation was 15%. At the time, the prime rate of interest was 21%, a record high. However, many investors expected the new Reagan administration to be more effective in controlling inflation than
6-18 YIELD CURVES Suppose the inflation rate is expected to be 7% next year, 5% the following year, and 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds(those that mature in a few
6-17 INTEREST RATE PREMIUMS A 5-year Treasury bond has a 5.2% yield. A 10-year Treasury bond yields 6.4%, and a 10-year corporate bond yields 8.4%. The market expects that inflation will average 2.5% over the next 10 years (IP10 ¼ 2.5%). Assume that there is no maturity risk premium (MRP ¼ 0) and
6-16 INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. A 6-year security with no maturity, default, or liquidity risk
6-15 EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If the 1-year bond yield is 5% and a 2-year bond (of similar risk) yields 7%, what is the 1-year interest rate that is expected for Year 2? What inflation rate is expected during Year 2?
6-14 EXPECTATIONS THEORY AND INFLATION Suppose 2-year Treasury bonds yield 4.5%, while 1-year bonds yield 3%. r* is 1%, and the maturity risk premium is zero.a. Using the expectations theory, what is the yield on a 1-year bond 1 year from now?b. What is the expected inflation rate in Year 1? Year 2?
6-13 DEFAULT RISK PREMIUM The real risk-free rate, r*, is 2.5%. Inflation is expected to average 2.8% a year for the next 4 years, after which time inflation is expected to average 3.75% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 8.3%, which
6-12 MATURITY RISK PREMIUM An investor in Treasury securities expects inflation to be 2.5%in Year 1, 3.2% in Year 2, and 3.6% each year thereafter. Assume that the real risk-free rate is 2.75% and that this rate will remain constant. Three-year Treasury securities yield 6.25%, while 5-year Treasury
6-11 DEFAULT RISK PREMIUM A company’s 5-year bonds are yielding 7.75% per year. Treasury bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate (r*) is 2.3%. The average inflation premium is 2.5%; and the maturity risk premium is estimated to be 0.1 × (t – 1)%,
6-7 EXPECTATIONS THEORY One-year Treasury securities yield 5%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 6%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities?
6-6 INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 5% and inflation is expected to
6-4 DEFAULT RISK PREMIUM A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
6-2 REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:l Inflation premium ¼ 3.25%l Liquidity premium ¼ 0.6%l
6-1 YIELD CURVES The following yields on U.S. Treasury securities were taken from a recent financial publication:a. Plot a yield curve based on these data.b. What type of yield curve is shown?c. What information does this graph tell you?d. Based on this yield curve, if you needed to borrow money
6-9 What does it mean when it is said that the United States is running a trade deficit? What impact will a trade deficit have on interest rates?
6-7 It is a fact that the federal government (1) encouraged the development of the savings and loan industry, (2) virtually forced the industry to make long-term fixed-interest-rate mortgages, and (3) forced the savings and loans to obtain most of their capital as deposits that were withdrawable on
6-6 Suppose a new and more liberal Congress and administration are elected. Their first order of business is to take away the independence of the Federal Reserve System and to force the Fed to greatly expand the money supply. What effect will this have:a. On the level and slope of the yield curve
6-5 Suppose a new process was developed that could be used to make oil out of seawater. The equipment required is quite expensive; but it would, in time, lead to low prices for gasoline, electricity, and other types of energy. What effect would this have on interest rates?
6-4 Suppose the population of Area Y is relatively young and the population of Area O is relatively old but everything else about the two areas is the same.a. Would interest rates likely be the same or different in the two areas? Explain.b. Would a trend toward nationwide branching by banks and the
6-1 Suppose interest rates on residential mortgages of equal risk are 5.5% in California and 7.0%in New York. Could this differential persist? What forces might tend to equalize rates?Would differentials in borrowing costs for businesses of equal risk located in California and New York be more or
28 Explain the following statement: The optimal financial policy depends in an important way on the nature of the firm’s assets.
27 If short-term interest rates are lower than long-term rates, why might a borrower still choose to finance with long-term debt?
26 Does the Fed have complete control over U.S. interest rates? That is, can it set rates at any level it chooses? Why or why not?
25 How does the Fed stimulate the economy? How does the Fed affect interest rates?
24 Identify some macroeconomic factors that influence interest rates and explain the effects of each.
23 Assume that the interest rate on a 1-year T-bond is currently 7% and the rate on a 2-year bond is 9%. If the maturity risk premium is zero, what is a reasonable forecast of the rate on a 1-year bond next year? What would the forecast be if the maturity risk premium on the 2-year bond was 0.5%
22 Most evidence suggests that a positive maturity risk premium exists. How would this affect your calculations when determining interest rates?
21 According to the pure expectations theory, what would happen if long-term rates were not an average of expected short-term rates?
20 Assuming that the pure expectations theory is correct, how are expected short-term rates used to calculate expected long-term rates?
19 What key assumption underlies the pure expectations theory?
18 Explain why corporate bonds always yield more than Treasury bonds and why BBB-rated bonds always yield more than AA-rated bonds.
17 Explain why corporate bonds’ default and liquidity premiums are likely to increase with their maturity.
16 If the inflation rate is expected to remain constant at the current level in the future, would the yield curve slope up, slope down, or be horizontal?Consider all factors that affect the yield curve, not just inflation.
15 If the inflation rate is expected to increase, would this increase or decrease the slope of the yield curve?
14 How do maturity risk premiums affect the yield curve?
13 If the interest rates on 1-, 5-, 10-, and 30-year bonds are 4%, 5%, 6%, and 7%, respectively, how would you describe the yield curve? If the rates were reversed, how would you describe it?
12 What is a yield curve, and what information would you need to draw this curve?Distinguish among the shapes of a “normal” yield curve, an “abnormal”curve, and a “humped” curve.
11 Assume that the real risk-free rate is r* = 2% and the average expected inflation rate is 3% for each future year. The DRP and LP for Bond X are each 1%, and the applicable MRP is 2%. What is Bond X’s interest rate? Is Bond X(1) a Treasury bond or a corporate bond and (2) more likely to have a
10 Briefly explain the following statement: Although long-term bonds are heavily exposed to interest rate risk, short-term T-bills are heavily exposed to reinvestment rate risk. The maturity risk premium reflects the net effects of those two opposing forces.
9 Distinguish between liquid and illiquid assets and list some assets that are liquid and some that are illiquid.
8 Does the interest rate on a T-bond include a default risk premium? Explain.
7 How do investors deal with inflation when they determine interest rates in the financial markets?
6 Distinguish between the real risk-free rate of interest, r*, and the nominal, or quoted, risk-free rate of interest, rRF.
5 Write an equation for the nominal interest rate on any security.
4 If inflation during the last 12 months was 2% and the interest rate during that period was 5%, what was the real rate of interest? If inflation is expected to average 4% during the next year and the real rate is 3%, what should the current rate of interest be? (3%; 7%)
3 How does risk affect interest rates?
2 How does the price of capital tend to change during a boom? during a recession?
1 What happens to market-clearing, or equilibrium, interest rates in a capital market when the supply of funds declines? What happens when expected inflation increases or decreases?
5-42 TIME VALUE OF MONEY ANALYSIS You have applied for a job with a local bank. As part of its evaluation process, you must take an examination on time value of money analysis covering the following questions:a. Draw time lines for (1) a $100 lump sum cash flow at the end of Year 2; (2) an ordinary
5-41 TIME VALUE OF MONEY Answer the following questions:a. Assuming a rate of 10% annually, find the FV of $1,000 after 5 years.b. What is the investment’s FV at rates of 0%, 5%, and 20% after 0, 1, 2, 3, 4, and 5 years?c. Find the PV of $1,000 due in 5 years if the discount rate is 10%.d. What
5-40 REQUIRED ANNUITY PAYMENTS A father is now planning a savings program to put his daughter through college. She is 13, she plans to enroll at the university in 5 years, and she should graduate in 4 years. Currently, the annual cost (for everything—food, clothing,tuition, books, transportation,
5-39 REQUIRED ANNUITY PAYMENTS Your father is 50 years old and will retire in 10 years.He expects to live for 25 years after he retires, until he is 85. He wants a fixed retirement income that has the same purchasing power at the time he retires as $40,000 has today. (The real value of his
5-38 PV AND A LAWSUIT SETTLEMENT It is now December 31, 2008 (t ¼ 0), and a jury just found in favor of a woman who sued the city for injuries sustained in a January 2007 accident.She requested recovery of lost wages plus $100,000 for pain and suffering plus $20,000 for legal expenses. Her doctor
5-37 PAYING OFF CREDIT CARDS Simon recently received a credit card with an 18% nominal interest rate. With the card, he purchased a new stereo for $350. The minimum payment on the card is only $10 per month.a. If Simon makes the minimum monthly payment and makes no other charges, how many months
5-36 NONANNUAL COMPOUNDINGa. You plan to make five deposits of $1,000 each, one every 6 months, with the first payment being made in 6 months. You will then make no more deposits. If the bank pays 4% nominal interest, compounded semiannually, how much will be in your account after 3 years?b. One
5-35 AMORTIZATION SCHEDULE WITH A BALLOON PAYMENT You want to buy a house that costs $100,000. You have $10,000 for a down payment, but your credit is such that mortgage companies will not lend you the required $90,000. However, the realtor persuades the seller to take a $90,000 mortgage (called a
5-34 AMORTIZATION SCHEDULEa. Set up an amortization schedule for a $25,000 loan to be repaid in equal installments at the end of each of the next 3 years. The interest rate is 10% compounded annually.b. What percentage of the payment represents interest and what percentage represents principal for
5-32 REACHING A FINANCIAL GOAL Six years from today you need $10,000. You plan to deposit$1,500 annually, with the first payment to be made a year from today, in an account that pays an 8% effective annual rate. Your last deposit, which will occur at the end of Year 6, will be for less than $1,500
5-31 REQUIRED LUMP SUM PAYMENT Starting next year, you will need $10,000 annually for 4 years to complete your education. (One year from today you will withdraw the first$10,000.) Your uncle deposits an amount today in a bank paying 5% annual interest, which will provide the needed $10,000
5-30 REACHING A FINANCIAL GOAL Erika and Kitty, who are twins, just received $30,000 each for their 25th birthday. They both have aspirations to become millionaires. Each plans to make a$5,000 annual contribution to her “early retirement fund” on her birthday, beginning a year from today. Erika
5-29 BUILDING CREDIT COST INTO PRICES Your firm sells for cash only; but it is thinking of offering credit, allowing customers 90 days to pay. Customers understand the time value of money, so they would all wait and pay on the 90th day. To carry these receivables, you would have to borrow funds
5-28 NOMINAL INTEREST RATE AND EXTENDING CREDIT As a jewelry store manager, you want to offer credit, with interest on outstanding balances paid monthly. To carry receivables, you must borrow funds from your bank at a nominal 6%, monthly compounding. To offset your overhead, you want to charge your
5-27 EFFECTIVE VERSUS NOMINAL INTEREST RATES Bank A pays 4% interest compounded annually on deposits, while Bank B pays 3.5% compounded daily.a. Based on the EAR (or EFF%), which bank should you use?b. Could your choice of banks be influenced by the fact that you might want to withdraw your funds
5-25 FUTURE VALUE OF AN ANNUITY Find the future values of the following ordinary annuities:a. FV of $400 paid each 6 months for 5 years at a nominal rate of 12% compounded semiannuallyb. FV of $200 paid each 3 months for 5 years at a nominal rate of 12% compounded quarterlyc. These annuities
5-24 PRESENT VALUE FOR VARIOUS DISCOUNTING PERIODS Find the present value of $500 due in the future under each of these conditions:a. 12% nominal rate, semiannual compounding, discounted back 5 yearsb. 12% nominal rate, quarterly compounding, discounted back 5 yearsc. 12% nominal rate, monthly
5-23 FUTURE VALUE FOR VARIOUS COMPOUNDING PERIODS Find the amount to which $500 will grow under each of these conditions:a. 12% compounded annually for 5 yearsb. 12% compounded semiannually for 5 yearsc. 12% compounded quarterly for 5 yearsd. 12% compounded monthly for 5 yearse. 12% compounded
5-22 LOAN AMORTIZATION Jan sold her house on December 31 and took a $10,000 mortgage as part of the payment. The 10-year mortgage has a 10% nominal interest rate, but it calls for semiannual payments beginning next June 30. Next year Jan must report on Schedule B of her IRS Form 1040 the amount of
5-21 EVALUATING LUMP SUMS AND ANNUITIES Crissie just won the lottery, and she must choose between three award options. She can elect to receive a lump sum today of$61 million, to receive 10 end-of-year payments of $9.5 million, or to receive 30 end-of-year payments of $5.5 million.a. If she thinks
5-20 PV OF A CASH FLOW STREAM A rookie quarterback is negotiating his first NFL contract.His opportunity cost is 10%. He has been offered three possible 4-year contracts. Payments are guaranteed, and they would be made at the end of each year. Terms of each contract are as
5-19 FUTURE VALUE OF AN ANNUITY Your client is 40 years old; and she wants to begin saving for retirement, with the first payment to come one year from now. She can save $5,000 per year; and you advise her to invest it in the stock market, which you expect to provide an average return of 9% in the
5-18 UNEVEN CASH FLOW STREAMa. Find the present values of the following cash flow streams at 8% compounded annually. 0 23$300$100$400$400$400$400$400$400$100$300$0$0 Stream A Stream B 1 4 5b. What are the PVs of the streams at 0% compounded annually?
5-17 EFFECTIVE INTEREST RATE You borrow $85,000; the annual loan payments are $8,273.59 for 30 years. What interest rate are you being charged?
5-16 PRESENT VALUE OF A PERPETUITY What is the present value of a $100 perpetuity if the interest rate is 7%? If interest rates doubled to 14%, what would its present value be?
5-15 PRESENT VALUE OF AN ANNUITY Find the present values of these ordinary annuities.Discounting occurs once a year.a. $400 per year for 10 years at 10%b. $200 per year for 5 years at 5%c. $400 per year for 5 years at 0%d. Rework Partsa, b, and c assuming they are annuities due.
5-14 FUTURE VALUE OF AN ANNUITY Find the future values of these ordinary annuities.Compounding occurs once a year.a. $400 per year for 10 years at 10%b. $200 per year for 5 years at 5%c. $400 per year for 5 years at 0%d. Rework Partsa, b, and c assuming they are annuities due.
5-13 TIME FOR A LUMP SUM TO DOUBLE How long will it take $200 to double if it earns the following rates? Compounding occurs once a year.a. 7%b. 10%c. 18%d. 100%
5-12 EFFECTIVE RATE OF INTEREST Find the interest rates earned on each of the following:a. You borrow $700 and promise to pay back $749 at the end of 1 year.b. You lend $700 and the borrower promises to pay you $749 at the end of 1 year.c. You borrow $85,000 and promise to pay back $201,229 at the
5-11 GROWTH RATES Shalit Corporation’s 2008 sales were $12 million. Its 2003 sales were$6 million.a. At what rate have sales been growing?b. Suppose someone made this statement: “Sales doubled in 5 years. This represents a growth of 100% in 5 years; so dividing 100% by 5, we find the growth
5-10 PRESENT AND FUTURE VALUES FOR DIFFERENT INTEREST RATES Find the following values. Compounding/discounting occurs annually.a. An initial $500 compounded for 10 years at 6%b. An initial $500 compounded for 10 years at 12%c. The present value of $500 due in 10 years at 6%d. The present value of

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