Managerial Finance Essay

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Question 5-2 Short Term bonds prices are less sensitive to interest rate changes than are long-term bond prices. For example if at 10% interest rate both the 25 year and the 1 year bonds are valued at $1,000. When rates rise to 15% the 25 year bond falls to $676.79, but the 1 year bond falls only to $956.52. This says that you would lose more on a long term bond than a short term bond. Problem 5-1 N=12 I=9 PV=0 PMT=80 FV=1000 PV=928.39 Problem 5-5 rT-10 = 6%; rC-10 = 9%; LP = 0.5%; DRP = ? r = r* + IP + DRP + LP + MRP. rT-10 = 6% = r* + IP + MRP; DRP = LP = 0. rC-10 = 8% = r* + IP + DRP + 0.5% + MRP. Because both bonds are 10-year bonds the inflation premium and maturity risk premium on both bonds are equal. The only difference between them is the liquidity and default risk premiums. rC-10 = 9% = r* + IP + MRP + 0.5% + DRP. But we know from above that r* + IP + MRP = 6%; therefore, rC-10 = 9% = 6% + 0.5% + DRP 2.5% = DRP. Quetion 6-2 A completely certain return would be tighter and more narrow, when a return is uncertain it would be wider. Question 6-3 Security A is less risky if held in a diversified portfolio because of its lower beta and negative correlation with other stocks. In a single-asset portfolio, Security A would be more risky because sA > sB and CVA > CVB Problem 6-3 rM = 5% + (6%)1 = 11%. rs = 5% + 6%(1.2) = 12.2%. Problem 6-4 .r = (0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) + (0.2)(25%) + (0.1)(60%) = 11.40%. s2 = (-50% - 11.40%)2(0.1) + (-5% - 11.40%)2(0.2) + (16% - 11.40%)2(0.4) + (25% - 11.40%)2(0.2) + (60% - 11.40%)2(0.1) s2 = 712.44; s= 26.69%. CV = 11.40% 26.69% =

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