BUS Chap 11 –homework problems

BUS Chap 11 –homework problems

ST 2,3,4,5,6,7  PP 6,14

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2. Maturity Premiums. Investments in long-term government bonds produced a negative average return during the period 1977–1981. How should we interpret this? Did bond investors in 1977expect to earn a negative maturity premium? What do these 5 years’ bond returns tell us about the normal future maturity premium? (LO11-1)

3. Risk Premiums. What will happen to the opportunity cost of capital if investors suddenly become especially conservative and less willing to bear investment risk? (LO11-1)

4. Risk Premium. If the stock market return next year turns out to be −20%, will our estimate of the “normal” risk premium increase or decrease? Does this make sense? (LO11-1)

5. Risk Premiums and Discount Rates. Top hedge fund manager Diana Sauros believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. UseTable 11.1 to find a reasonable discount rate. (LO11-1)

6. Risk Premiums. Here are stock market and Treasury bill percentage returns between 2008 and2012: (LO11-1)

Year               Stock Market Return                     T-Bill Return

2008               −37.23                                                1.60

2009               28.30                                      0.10

2010               17.16                                      0.12

2011               0.98                                        0.04

2012               16.06                                      0.06

1. What was the risk premium on common stock in each year?

1. What was the average risk premium?

1. What was the standard deviation of the risk premium?

7. Rate of Return. A stock is selling today for $40 per share. At the end of the year, it pays a dividend of $2 per share and sells for $44. (LO11-2)

1. What is the total rate of return on the stock?
2. What are the dividend yield and percentage capital gain?
3. Now suppose the year-end stock price after the dividend is paid is $36. What are the dividend yield and percentage capital gain in this case?
4. Why is the dividend yield the same in parts (b) and (d)?