Question 1 Pricing Bonds and Stock (20 points) Ten years ago today, Excel Corp i

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Question 1 Pricing Bonds and Stock (20 points) Ten years ago today, Excel Corp issued a regular coupon bond that had original maturity of 20 years. The bond pays interest semiannually and has a coupon rate of 5%. The bond was originally issued at par. Since the bond was issued, market interest rates have generally moved down such that today the Yield to Maturity (YTM) on the bond is 4%. Estimate the price of the bond today, assuming semi-annual interest payments. (5 points) a. If Excel Corp. had issued a zero coupon bond with 20 years to maturity 10 years ago, and market conditions were the same as for the coupon bond issue, what would be the price that the zero coupon bond would have sold for? am saying here that the Required return on Excel bonds 20 years ago was the same for the coupon bond and the zero coupon bond. You may assume annual compounding in this situation. (5 points) b. On July 25, 2018 Facebook reported lower than expected user growth for the second quarter. Additionally, the company lowered its earnings growth target for the full year of 2018. On July 25, Facebook shares fell by 20%, wiping out about $100 billion in market value. Provide a one-paragraph explanation (30-40 words) of the market reaction to this news. (10 points) c.

Explanation / Answer

1a: N= 20-10 = 10*2 = 20 semiannual periods

Coupon = 5%*1000/2 = 25

YTM= 4%/2 = 2%

Price= C*(1-1/(1+r)^n)/r + FV/(1+r)^n

= 25*(1-1/1.02^20)/0.02 + 1000/1.02^20

=$ 1081.76

B: N= 20 (since we want to find the original price of the ZCB)

YTM= 5% (Since the coupon bond was issued at par, the ytm at time of issue= coupon rate)

Price of ZCB= FV/(1+r)^n

= 1000/1.05^20

= $376.89

C: As the user growth did not meet the expectations, it implies lack of growth in the overall business. The market anticipated lesser profitability since lack of user growth implies decline of customer base. This led to the decline of share price since share prices reflect the market expectations of cash flows of the company.

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