Question 1) Part A
You are considering three alternatives investments in bonds but would like to gain the impression of the extent of price volatility for each given alternative changes in future interest rates. The investments are:
I. A two year bond with the annual coupon of 6 per cent, par value of Rs 100 and next coupon payment in one year. The present yield to maturity on this bond is 6.5 per cent.
II. A ten year bond with an annual coupon of 6 percent a par value of Rs 100 and the next coupon payable in one year. The present yield to maturity on this bond is 7.2 per cent.
III. A twenty year bond with an annual coupon of 6 per cent, a par value of Rs 100 and next coupon due in one year. The current yield to maturity on this bond is 7.7 per cent.
Required:
a. Draw the suitable yield curve.
b. Compute the market price of each of the bonds.
c. Compute the market price of the bonds on the assumption that yields to maturity rises by 200 basis points for all bonds.
d. Compute the market price of the bonds on the assumption that yields to maturity fall by 200 basis points for all bonds.
e. Which bond price is the most volatile in circumstances of changing yields to maturity? Provide supporting reasons. Part b:
You own shares of Dickson’s preferred stock, which currently sells for Rs. 400 per share and pays an annual dividend of Rs. 42.50 per share.
(i) Compute expected return.
(ii) If you require an 8% return, given the price, must you sell or buy more stock?
(iii) The earnings of the Company have increased over a 10 – year period to Rs 57.
Compute the rate of growth of the earnings per share.
(iv) Why is preferred stock more similar to debt than equity?