FI 414 Section 2 Spring 2023 Problem Set 2 Due Feb 6, 100 points Problem 1 (Bond Valuation, 50 points) Here is a schedule for bond yields of different ratings: Rating Yield (APR) AAA 2% BBB 6% C 12% Answer the following questions using the information in the table. Show your calculations. Hint: get effective yield, coupons and time periods first. 1) Firm A has recently issued a 5-year bond that is rated as "AAA", with a face value of $1000, annual coupon rate of 5%, paid semi-annually, how much should the price be? (20 points) 2) Firm B has recently issued a 3-year bond that is rated as "C", with a face value of $1000, annual coupon rate of 4%, paid semi-annually, how much should the price be? (20 points) 3) You found out that the market is pricing the firm A bond at $950 and firm B bond at $1250, which of the following should you do to exploit the situation? Give a very brief explanation. (10 points) a) Long firm A bond and short firm B bond. b) Short firm A bond and long firm B bond. c) Do nothing and forget about the opportunity. Problem 2 (Stock Valuation, 50 points) You are a firm believer in the Capital Asset Pricing Model (CAPM). You collected the following information for Firm C and D stocks: The risk-free rate is 2% The market risk premium is 6% Firm C has a CAPM beta of 1.2, just paid an annual dividend of $2 per share, and you believe it's going to continue paying that amount each year forever since it is a "boring" company. Firm D has a CAPM beta of 2.5, just paid an annual dividend of $1 per share, you believe for the next 5 years its dividend is going to grow by 10% per year (so year 1 dividend is $1.1, year 5 is thus $1 x 1.1"), but from year 6, its dividend is going to stay constant at its year 5 level forever.Answer the following questions using the dividend discount model. Show your calculations. Hint: think about annuity, perpetuity and general DCFs. Make sure the timing is correct. 1) What is the right price for stock C? (20 points) 2) What is the right price for stock D? (20 points) 3) You found out the market is pricing C at $35 and D at $4.9, which of the following shou you do to exploit the situation? Give a very brief explanation. (10 points) a) Long C and Short D b) Short C and long D c) Do nothing and forget about everything you learned in finance