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Chapter 5: 4DQ (page 493)
Discuss the reason for the differences between underwriting spreads for stocks and bonds.
The major reason for the difference between underwriting spreads for stocks and bonds is the amount paid by the issuer and proceeds.
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Question: The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11戮 percent seven years ago. Interest rates have fallen to 10戮 percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the after-tax cost of new debt rounded up to the nearest whole number.
c. Calculate the present value of total inflows.
Do corporations rely more on external or internal funds as sources of financing?
The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D1) at the end of the current year will be \(1.64. The growth rate (g) is 8 percent and the discount rate (Ke) is 13 percent.
a. What should be the price of the stock to the public?
b. If there is a 7 percent total underwriting spread on the stock, how much will the issuing corporation receive?
c. If the issuing corporation requires a net price of \)31.30 (proceeds to the corporation) and there is a 7 percent underwriting spread, what should be the price of the stock to the public? (Round to two places to the right of the decimal point.)
An investor must choose between two bonds: Bond A pays \(72 annual interest and has a market value of \)925. It has 10 years to maturity. Bond B pays \(62annual interest and has a market value of \)910. It has two years to maturity.
Assume the par value of the bonds is $1,000.
a.Compute the current yield on both bonds.
b.Which bond should she select based on your answer to part a?
c.A drawback of current yield is that it does not consider the total life of thebond. For example, the yield to maturity on Bond A is 8.33 percent. What isthe yield to maturity on Bond B?
d.Has your answer changed between parts band cof this question in terms ofwhich bond to select?
What are electronic communication networks (ECNs)? Generally speaking, are they currently part of the operations of the New York Stock Exchange and the NASDAQ Stock Market?
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