Question

four years ago, sam invested in grath oil. she bought three of its $1,000 par value bonds at a market price of 93.938 and with an annual coupon rate of 6.5%. she also bought 450 shares of grath oil stock at $44.11, which has paid an annual dividend of $3.10 for each of the last ten years. today, grath oil bonds have a market rate of 98.866 and grath oil stock sells for $45.55 per share. use the scenario above to select the best answer. a. it is equally likely that the company would suspend paying interest on the bonds and dividends on the stock. b. both the coupon rate and the dividend rate are fixed and cannot change. c. the bonds showed a higher percentage return than that of the stocks. d. the amount of money received annually in interest (on the bonds) and in dividends (on the stocks) depends on the current market prices. please select the best answer from the choices provided

Explanation:

Step1: Analyze Option a

Bonds are debt instruments, and companies have a legal obligation to pay bond interest (unless in default), while stock dividends are discretionary. So suspending both is not equally likely. Eliminate a.

Step2: Analyze Option b

Coupon rate of bonds is fixed (based on par value), but dividend rate (for stocks) can change as companies can adjust dividends. So b is incorrect.

Step3: Calculate Bond Return

• Par value = $1000, bought at 93.938% of par: Purchase price per bond = \( 1000 \times 0.93938 = 939.38 \)
• Current price per bond = \( 1000 \times 0.98866 = 988.66 \)
• Annual coupon = \( 1000 \times 6.5\% = 65 \)
• For 3 bonds, total purchase cost = \( 3 \times 939.38 = 2818.14 \)
• Total current value = \( 3 \times 988.66 = 2965.98 \)
• Total coupon income over 4 years = \( 3 \times 65 \times 4 = 780 \)
• Total return for bonds = \( (2965.98 - 2818.14 + 780) = 927.84 \)
• Percentage return for bonds = \( \frac{927.84}{2818.14} \approx 0.3292 \) (32.92%)

Step4: Calculate Stock Return

• Purchase price per share = $44.11, current price = $45.55
• Annual dividend = $3.10, for 450 shares
• Total purchase cost = \( 450 \times 44.11 = 19849.5 \)
• Total current value = \( 450 \times 45.55 = 20497.5 \)
• Total dividend income over 4 years = \( 450 \times 3.10 \times 4 = 5580 \)
• Total return for stocks = \( (20497.5 - 19849.5 + 5580) = 6228 \)
• Percentage return for stocks = \( \frac{6228}{19849.5} \approx 0.3138 \) (31.38%)
• Bonds have higher percentage return than stocks, so c is correct.

Step5: Analyze Option d

Bond interest is based on par value (fixed), stock dividends are based on number of shares (fixed, unless dividend rate changes), not current market prices. So d is incorrect.

Answer:

c. The bonds showed a higher percentage return than that of the stocks.