Valuation of Bonds and Equities      -  Tutorial 3  

Question 1. 

Bubble Plc plans to issue a bond with 5 years to maturity. The Bubble bond has a coupon of £20.00 and the face value of £500.00. Similar bonds have yield to maturity 4%.

a. What are the bond cash flows?
b. What would this bond sell for?
c. What is the relationship between price of a bond and its YTM?
d. Explain why some bonds sell at a premium over par value while other bonds sell at a discount. What do you know about the relationship between the coupon rate and the YTM for premium bonds? What about for discount bonds? For bonds selling at par value?
e. What is the relationship between the current yield and YTM for premium bonds? For discount bonds? For selling at par value? 

Answer a.

Bond Cash flows are the payments received (interest) annually by the Bond Holder the final such payment is paid together with the face value of the bond at maturity.

Answer b.

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Answer c.

The yield to maturity is the discount rate which returns the market price of the bond.  So it is an expression of all the discounted coupons and the discounted Face Values at maturity

Answer d.

Bonds can sell above or below the Price index - those above are said to sell at a premium,Those below sell at a discount, Par Bonds are expected to retain thier value.
Answer e.
The current Yield is the current value divided by the coupon rate, for Premium Bonds could be lower than the YTM due to price higher than face value, conversly Discounted bonds may produce a higher current Yield as the selling price of the bonds are lower than face value.  Par Bonds should have a current yield equal to the YTM.

 Question 2.  

Oasis plc has just paid a dividend of £6 per share. The dividend of this company grows at a steady rate of 10 per cent per year. Based on this information, what will the dividend be in five years?

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Question 3.  

Three companies are all in the same type of business.

ABC Ltd expects to pay a dividend of £10.00 forever;
BCD Ltd expects to pay a dividend next year of £5.00 with growth thereafter of 4% per year; 
CDE Ltd dividend expects to grow at 20% for the next 5 years. The dividend just paid was £5. After that, the growth is expected to be zero percent forever.

If investors require a return of 10%, which of the above companies will have the highest share price?

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Question 4. 

Hathaway plc is a UK based manufacturing company. The company is all equity financed and recent dividend history of the company has shown a constant growth rate of 10% which is expected to continue for the foreseeable future. The dividend for 2011 was 6.0p per share.

The management of Hathaway plc are considering investing a new manufacturing facility. To finance the new manufacturing facility the management of Hathaway plc are considering reducing the dividend for 2012, 2013 and 2014 to 2.0p per share and then increasing the dividend to 8.0p per share in 2015 with an expected growth rate of 8% pa thereafter.

Assume a required rate of return of 13%.

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