Pete.Docx

2)But as insights from academia arrived in the rough and tumble of Wall Street, such delicacies were put aside. And absurd assumptions were added. No economic theory suggests you should value mortgage derivatives on the basis that house prices would always rise. Finance professors are not to blame for this, but they might have shouted more loudly that their insights were being misused. Instead many cheered the party along (often from within banks). Put that together with the complacency of the macroeconomists and there were too few voices shouting stop.

Solutions to questions from chapter 6, Ross 5th edition.

8.Debenture B would have the larger price change because it has a longer maturity.

Debenture A: Price = 9 × PVIFA(4,11%) + 100/(1.11)4

= 9 × 3.1024 + 65.87 = $ 93.79

Debenture B: Price = 9 × PVIFA(8,11%) + 100/(1.11)8

= 9 × 5.1461 + 43.39 = $89.70

10.Price= 16/(1.20)4 + 16/(1.20)5 + [100 + ( 4 ×16)]/(1.20)6

= 7.72 + 6.43 + 54.92 = $69.07

18.P4 = 0.4(1.12)4(1.04)/(0.16 − 0.04) = $5.455

P0 = 0.4(1.12)/(1.16) + 0.4(1.12)2/(1.16)2 + 0.4(1.12)3/(1.16)3 + [0.4(1.12)4 + 5.455]/(1.16)4

= 0.39 + 0.37 + 0.36 + 3.36

= $4.48

29.V = [0.8M/(0.16 + 0.04)] −3.5M = $0.5 million

26.D1 = 0.20(1.25); D2 = $0.25(1.2); D3 = $0.30(1.15); D4 = $0345(1.1)

P4= $0.3795(1.05)/(0.16 − 0.05) = $3.6225

P0= 0.25/1.16 + 0.30/(1.16)2 + 0.345/(1.16)3 + (0.3795 +3.6225)/(1.16) 4

= 0.216 + 0.223 + 0.221 + 2.210

= $2.87

27.2.79 = 0.25/(1 + r) + 0.30/(1 + r)2 + 0.345/(1 + r)3 + 0.3795/(1 + r)4 + [0.3795(1.05)/(r − 0.05)]/(1 + r)4

We know from Q26 that r is very close to 16% because it gave Po = $2.87

At 16.2% Po = $2.82

At 16.3% Po = $2.79 so r is very close to 16.3%

r = 16.3%

MINI CASE,

SOLUTIONS—MINICASE: STOCK VALUATION AT RAGAN LTD

1.The total dividends paid by the company were $126,000. Since there are 100,000 shares outstanding, the total earnings for the company were:

Total earnings = 100,000($4.54) = $454,000

This means the payout...