Question 1
Suppose that General Motors Acceptance Corporation issued a bond with ten years until maturity, a face value of $1,000 and a coupon rate of 7% (annual payments). The yield to maturity on this bond when it was issued was 6%.

a) What was the price of this bond when it was issued?
b) Assuming the yield to maturity remains constant, what is the price of the bond immediately before it makes its first coupon payment?
c) Assuming the yield to maturity remains constant what is the price of the bond immediately after it makes its first coupon payment?

Question 2
DFB, Inc expects earnings this year of $5 per share and it plans to pay a $3 dividend to shareholders. DFB will retain $2 per share of its earnings to reinvest in new projects with an expected return of 15% per year. Suppose DFB will maintain the same dividend payout rate, retention rate and return on new investments in the future and will not change its number of outstanding shares.

a) What growth rate of earnings would you forecast for DFB?
b) If DFB’s equity cost of capital is 12%, what price would you estimate for DFB stock?
c) Suppose DFB instead paid a dividend of $4 per share this year and retained only $1 per share in earnings. If DFB maintains this higher payout rate in the future, what stock price would you estimate now? Should DFB raise its dividend?

Question 3
Suppose you have $20,000 in cash to invest. You decide to short sell $10,000 worth of Coca-Cola and invest the proceeds from your short sale plus your $20,000 in Intel.

a) At the end of the year you decide to liquidate your portfolio. If the two stocks have the following realized returns, what is the return on your portfolio?

Initial price Closing price + div Return
Intel 25 31.50 26%
Coca-Cola 40 42.40 9%

b) Intel stock has a volatility of 50%, Coca-Cola has a volatility of 25% and the stocks are uncorrelated. What is the volatility of a portfolio that is short $10,000 of Coca-Cola and long $30,000 of Intel?

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