FINANCIAL MARKETS AND
INSTITUTIONS (BUS340)
Interest Rates and Security Valuation
(Seminar Notes)
Dr Ni Peng
1
Q1: QUESTIONS

What is the difference between a required rate of return
and an expected rate of return?

Analysis note:
Required rate of return
Expected rate of return
2
Q1: SUGGESTED ANSWERS

The required rate of return is the interest rate an
investor should receive on a security given its risk.
Required rate of return is used to calculate the fair
present value on a security.

The expected rate of return is the interest rate an
investor expects to receive on a security if he or she
buys the security at its current market price, receives
all expected payments, and sells the security at the
end of his or her investment horizon.
3
Q2: QUESTIONS
Is the statement below true or false?
 A bond with an 11 percent coupon and a 9 percent
required return will sell at a premium to par.
 True
 False
 Analysis note:

4
Q2: SUGGESTED ANSWERS

A bond with an 11 percent coupon and a 9 percent required return
will sell at a premium to par.


True√
False

Suggested answer: A
5
Q3: QUESTIONS
You bought a bond five years ago for $935 per bond. The
bond is now selling for $980. It also paid $75 in interest
per year, which you reinvested in the bond. You expect to
hold the bond for three more years, then sell it for $990.
If the bond is expected to continue paying $75 per year
over the next three years, what is the expected rate of
return on the bond during this period?
 (*would be easier to calculate using financial calculator)

6
Q3: ANALYSIS NOTE & SUGGESTED ANSWERS

You bought a bond five years ago for $935 per bond. The bond is now
selling for $980. It also paid $75 in interest per year, which you reinvested in
the bond. You expect to hold the bond for three more years, then sell it for
$990. If the bond is expected to continue paying $75 per year over the next
three years, what is the expected rate of return on the bond during this
period?

Analysis note:
7
Q4A: QUESTIONS
Calculate the yield to maturity on the following bonds:
 a. A 9% coupon (paid semi-annually) bond, with a $1,000
face value and 15 years remaining to maturity. This bond
is selling at $985.
 Analysis note:

8
Q4A: ANALYSIS NOTE & SUGGESTED ANSWERS
9
Q4B&C: QUESTIONS

Calculate the yield to maturity on the following bonds:

b. An 8% coupon (paid quarterly) bond, with a $1,000 face value and 10
years remaining to maturity. This bond is selling at $915.

c. An 11% coupon (paid annually) bond, with a $1,000 face value and 6
years remaining to maturity. This bond is selling at $1,065.

Analysis note:
10
Q4B&C: SUGGESTED ANSWERS

Calculate the yield to maturity on the following bonds:

b. An 8% coupon (paid quarterly) bond, with a $1,000 face value and 10
years remaining to maturity. This bond is selling at $915.

c. An 11% coupon (paid annually) bond, with a $1,000 face value and 6
years remaining to maturity. This bond is selling at $1,065.
11
Q5: QUESTIONS

A preferred stock from Hecla Co. pays $3.50 in annual
dividends (zero growth in dividends). If the required rate
of return on the preferred stock is 6.8%, what is the fair
present value of the stock?

Analysis note:
12
Q5: SUGGESTED ANSWERS

A preferred stock from Hecla Co. pays $3.50 in annual
dividends (zero growth in dividends). If the required rate
of return on the preferred stock is 6.8%, what is the fair
present value of the stock?

P = D/Rs = 3.50/0.068 = $51.47
13
Q6: QUESTIONS
Financial analyst forecasts Safeco Corp growth rate for
the future to be 10 percent. Safeco’s recent dividend was
$1.20. What is the fair present value of Safeco stock if
the required rate of return is 12 percent?
 Analysis note:

14
Q6: SUGGESTED ANSWERS



Financial analyst forecasts Safeco Corp growth rate for
the future to be 10 percent. Safeco’s recent dividend was
$1.20. What is the fair present value of Safeco stock if
the required rate of return is 12 percent?
Po = 1.20*(1 + 0.10) = $66.00
0.12 - 0.10
15