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1
1.) A 10?year, 6.2?percent coupon bond is selling for 102.6 percent of par. What is the bond's market yield if it makes semi?annual coupon payments?
2.) Oriole Mechanical Ltd.'s preferred shares have a par value of $50, a dividend rate of 9.0 percent, and trade at a price of $75. Waterway Inc.'s preferred shares have a par value of $60, have a dividend rate of 5.0 percent, and trade at a price of $40.
Which company's preferred stock is riskier? What is each required rate of return?
Expert Solution
1) Computation of Bond's Market Yield using Rate Function in Excel:
=rate(nper,pmt,-pv,fv)*2
Here,
Rate = Yield to Maturity = ?
Nper = 10 years*2 = 20 Periods
PMT = $1,000*6.2%/2 = $31
PV = $1,000*102.6% = $1,026
FV = $1,000 (assumed)
Substituting the values in formula:
=rate(20,31,-1026,1000)*2
Rate or Yield to Maturity = 5.85%
2) Computation of Required Return on Preferred Stock:
Required return on preferred stock = Annual dividend/Current market price
Annual dividend = Dividend Rate * Par Value
For Oriole Mechanical Ltd., Annual Dividend = $50 * 9% = $4.50
Required return = $4.50/$75 = 6.00%
For Waterway Inc. Annual Dividend = $60 * 5% = $3
Required return = $3/$40 = 7.50%
Given required return for Waterway Inc. is higher, it is riskier preferred stock of the two.
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