ECON 454 Economics of Corporations

• Show your work and answer in the space provided below each question; add space as needed.
• Type in your answers or clearly/legibly handwrite down your answers.
• Submission: Upload your typed work or a scanned PDF file of your handwritten work to Blackboard by clicking on the HWK link where this assignment is posted. No photo, please. One free app (basic) that I have found useful, which you can download, is called “FastScanner”.
• Include your name above and in the electronic file name, along with your class section.
• A penalty of up to 5 points deducted from the score on this assignment will apply for no compliance with the above instructions.

FULL NAME: _____________________________________________

 

ECON 454-91: ECONOMICS OF CORPORATIONS

Non-MyLab HOMEWORK #1 [60 points in total] – Chapters 4, 5 and 6.

Due date: No later than 11:59pm EST, 11/06/2020, on Blackboard in myCourses.

 

Instructions:

• Show your work and answer in the space provided below each question; add space as needed.
• Type in your answers or clearly/legibly handwrite down your answers.
• Submission: Upload your typed work or a scanned PDF file of your handwritten work to Blackboard by clicking on the HWK link where this assignment is posted. No photo, please. One free app (basic) that I have found useful, which you can download, is called “FastScanner”.
• Include your name above and in the electronic file name, along with your class section.
• A penalty of up to 5 points deducted from the score on this assignment will apply for no compliance with the above instructions.

 

1. [10 points] Century Zoom, Inc. has decided to refinance the mortgage on one of its administrative buildings. The company plans to borrow whatever is outstanding on its current mortgage. The current monthly payment is $2,356 and the company has made every payment on time. The original term of the mortgage was 30 years, and the mortgage is exactly four years and eight months old. The company has just made its monthly payment. The mortgage interest rate is 6(APR). How much does the company owe on the mortgage today?

 

 

 

 

 

 

2. [5 points] Elf Electronics, Inc. needs to arrange financing for its expansion program. Bank Aba offers to lend Elf Electronics the required funds on a loan in which interest must be paid monthly, and the quoted rate is 8 percent. Bank Bo will charge 9 percent, with interest due at the end of the year. Which bank offers better the lowest cost of borrowing to Elf Electronics, ceteris paribus? Why?

 

 

 

 

 

 

3. [5 points] Suppose you are a member of your company’s strategic plan that strives to maintain a well-motivated staff. One of the tasks assigned to your planning committee is to make recommendations on a long-term compensation policy that will help the payroll keep up with inflation, which is one of the key variables in the decision-making process. The expected inflation is a key determinant of the purchasing power earnings. Suppose you currently know that at an inflation rate of 9 percent the purchasing power of $1 would be cut in half in 8.04 years. However, since the macroeconomic environment has recently improved significantly, your committee would like to know how long to the nearest year it would take the purchasing power of $1 to be cut in half if the inflation rate were only 4 percent. Please, provide the answer for this question, which is part of the tasks that have been assigned to you. Show supporting work.

 

 

 

 

 

4. [10 points – 2.5 pts. for each part] The mortgage on your house is five years old. It required monthly payments of $1402, had an original term of 30 years, and had an interest rate of 10% (APR). In the intervening five years, interest rates have fallen and so you have decided to refinance—that is, you will roll over the outstanding balance into a new mortgage. The new mortgage has a 30-year term, requires monthly payments, and has an interest rate of 6 5⁄8% (APR).
5. What monthly repayments will be required with the new loan?
6. If you still want to pay off the mortgage in 25 years, what monthly payment should you make after you refinance?
7. Suppose you are willing to continue making monthly payments of $1402. How long will it take you to pay off the mortgage after refinancing?
8. Suppose you are willing to continue making monthly payments of $1402, and want to pay off the mortgage in 25 years. How much additional cash can you borrow today as part of the refinancing?

 

 

 

 

 

 

 

 

5. [5 points] A 10-year corporate bond has an annual coupon payment of 9 percent. The bond is currently selling at par ($1,000).  Which of the following statements is most correct?
6. The bond’s yield to maturity is 9 percent.
7. The bond’s current yield is 9 percent.
8. If the bond’s yield to maturity remains constant, the bond’s price will remain at par.
9. All of the statements above are correct.

 

 

 

 

6. [10 points – 2.5pts, 2.5pts. and 5 pts., respectively.] Suppose you would like to buy today a five-year, $1000 bond with a 5% coupon rate and semi-annual coupons. The bond was issued exactly one year earlier today. The current market interest rate on similar bonds is 6%.

 

1. What should the price of this bond be today?

 

 

1. Suppose that you hold the bond until its maturity, what should be your total rate of return on this bond?

 

 

878. Now, suppose you bought the bond at its fair price today and one year later you sell the bond for $878.34. When you sell:

• What is the bond’s nominal yield?
• What is the bond’s yield to maturity?
• What is the bond’s current yield?
• What is your total return on the bond, all other things being equal?
• If your personal tax rate is 20% and the annual inflation rate is expected to be 2%, what is your after-tax real rate of return?

 

 

 

[5 points] Your corporate research team has come up with the following zero-coupon yields:

Maturity                                        1 year              2 years             3 years             4 years

Zero-coupon yield to maturity      3.50%              4:00%              4.5%                4.75%

 

Given the information provided in this table and assuming a $1,000 face value:

1. What is the value of a 3-year coupon bond with 4% annual coupons?

 

1. Which of the following bonds has the highest yield to maturity: A 3-year coupon bond with 4% annual coupons or a 3-year coupon bond with 10% annual coupons? All of these bonds are default free. Why? (SHOW WORK)

 

 

 

 

8. [10 points] Green Hat, Inc. decides to issue a $1000 bond with a 5% coupon rate, paid semiannually, and 10 years until maturity.

 

1. If the market interest for similar bonds is the same as Green Hat coupon, what is the bond price at issuance, all else being equal?

 

 

1. What should the yield to maturity of this bond be exactly two years after its issuance and if it is trading at $935, all else being equal?