ACCA FM Syllabus B. Financial Management Environment - Risk and Return of different securities - Past Papers ^{4 / 5}

In relation to an irredeemable security paying a fixed rate of interest, which of the following statements is correct?

A. As risk rises, the market value of the security will fall to ensure that investors receive an increased yield
B. As risk rises, the market value of the security will fall to ensure that investors receive a reduced yield
C. As risk rises, the market value of the security will rise to ensure that investors receive an increased yield
D. As risk rises, the market value of the security will rise to ensure that investors receive a reduced yield

DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is $0·50 per share and it expects that its next dividend per share, payable in one year’s time, will be $0·52 per share.

The capital structure of the company is as follows:

Bond A will be redeemed at nominal in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year. The current ex interest market price of the bond is $95·08.

Bond B will be redeemed at nominal in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year. The current ex interest market price of the bond is $102·01.

DD Co has a cost of equity of 12·4%. Ignore taxation.

Required:
(c) Explain why DD Co’s capital instruments have different levels of risk and return. (5 marks)