Stocks and Bonds 1a) the

Stocks and Bonds 1a) the yield to maturity on bond #1 is 5.48%. The yield to maturity on bond #3 is 5.68%. The price of bond #2 is 97.44. The price of bond #4 is $97.83. The price of bond #5 is $75.75. A b) c) This represents a normal yield curve. In this scenario, it is expected that the economy will continue to grow at a normal rate. Therefore, higher yields are required on longer-term securities in order to entice investors. This accounts for the risk associated with the passage of time.

The longer the time frame, the greater the uncertainty (Investopedia, 2008). The three main attributes of the curve are the level, the slope and the curvature. If interest rates drop, the level will rise, as YTM rises when interest rates decline. The slope is determined by the spread between long-term rates and short-term rates. In this case, the slope rises quickly because there is a significant jump in the six-year rates over the shorter-term maturities.

The curvature relates mainly to medium-term rates, and is not a major factor in this curve because the maturities measured only go out six years (Wu, 2003). Curvature can be seen on the Treasury yield curve, however, as the spread between the 5-year and 10-year bonds is significant, representing market sentiment that risk is higher in this period than in other periods along the curve. A d) the new price of bond #1 is 100.22. The new price of bond #2 is 98.80. The new price of bond #3 is 104.10. The new price of bond #4 is 100.30.

The new price of bond #5 is 77.88. The bond that exhibited the greatest percentage price movement was bond #5. The bond that exhibited the smallest percentage price movement was bond #1. A e) the new price of bond #1 is 98.39. The new price on bond #2 is 96.15. The new price of bond #3 is 100.35. The new price of bond #4 is 95.43. The new price of bond #5 is 73.69. The bond that exhibited the greatest percentage price movement was bond #5. The bond that exhibited the smallest percentage price movement was bond #1.

A f) the conclusions that can be drawn from d & e are that investors who invest in bonds with a short maturity face lower risk than investors who hold bonds with medium or longer term maturities. Strong interest rate shocks both upward and downward had the smallest impact on the bonds with the shortest maturities. In both cases, the bonds that were the most severely affected by the interest rate shocks were the longer-term maturities.

A g) Even Treasury bonds are risky, because short-term fluctuations in the interest rate can impact the value of the cash flows that they are to receive. The main difference between corporate bonds and Treasury bonds is that the latter are guaranteed by the government. Thus, they are considered risk free, in the sense that there is no default risk, only market risk. Corporate bonds, however, contain default risk.

Therefore, it is important for the issuers of corporate bonds to understand that they must add in a risk premium to account for the default risk. The degree of default risk will be measured by bond rating agencies and that will determine the risk premium that the corporation must pay in order to raise funds in the bond market. 2. The three components of stock prices according to the dividend growth model are the current dividend, the expected growth rate of dividends, and the discount rate for future cash flows.

The current dividend is generally known, except for companies that do not pay one. The expected growth rate can be extrapolated either from past dividend growth rates or the company's overall growth rate compared to its plowback rate. The discount rate is generally calculated as the cost of equity. There are several practical issues with regards to the use of the dividend growth model in order to determine the price of the.