This assignment consists of several questions relating to the valuation of stocks, bonds, and options that can be answered individually or in groups of up to four students.
Part 1: Stocks
Based on our discussion on stock valuation in general and the application of the Dividend Discount Model (DDM) in particular, please solve the following tasks:
1. Go to the Yahoo! Finance website (https://finance.yahoo.com) and enter the symbol for a company of your choice that trades at the NYSE. From the main page for this stock, gather the following information and enter it into a spreadsheet:
a. The current stock price
b. The current dividend amount
2. In the section "Key Statistics" gather:
a. The number of shares outstanding
b. The payout ratio
3. In the section "Analyst Estimates" find the expected growth rate for the next five years and enter it onto your spreadsheet.
4. Determine the stock price based on the DDM (assume a required rate of rate of 7.5%) (4 points each):
a. Use the dividend obtained as the current dividend and determines the future dividends for the next five years (based on estimated growth rate and payout ratio).
b. Determine the current stock price according to the DDM (this may be different from the actual stock price. If so, state if you recommend buying or selling this stock as why).
c. Determine the expected stock price five years from now, according to the DDM
5. The Wealth Corp. is assumed to make the following annual dividend payments:
D0 = $0.95, D1 = $1.19, D2 = $1.48, D3 = $1.86, D4 = $2.32, D5 = $2.90, D6 = 3.62. Subsequently, the dividends are expected to increase by 3.5% annually in perpetuity. Given a required rate of return of 9.75%,
a) What would be your estimate of a fair price for the company's shares using the DDM?
b) What would be your estimate of a fair price for the company's shares using the H-Model?
6. For questions a-d, consider the following information:
You buy 5000 shares of stock on margin at $35 per share. The initial margin is 55% and the maintenance margin is 45%.
a. What would be the minimum equity amount required for your transaction at the time of purchase?
b. What would be the actual margin on your position if the stock price drops to $23?
c. At what stock price would you receive a margin call and why?
d. At a stock price of $42.25, how much cash could you withdraw from your account and still have the necessary margin level for your transaction?
Part 2: Bonds
Today, on June 5, 2016 you buy a bond of the Wealth Corp. that has a face value of $1,000. The bond makes semi-annual coupon payments of $45 each. The maturity date is December 12, 2020. Investors require a rate of return for bonds of similar risk of 8.65%.
1. Compute the bond price on the day of purchase:
2. Compute the current yield:
3. Assume you sell the bond one year from the date of purchase, compute your capital gain/loss yield for the one-year investment period (assume no change in the interest rate):
4. If the bond trades at a price of $971.25 on September 14, 2018, compute the yield on that day:
5. You buy a bond on April 16, 2013 that was issued on October 12, 2001 and that will expire on July 31, 2021. The bond has a par value of $1,000, making semi-annual coupon payments of $43. The bond is currently trading at a dollar price of $956.75.
a. Compute the amount of accrued interest on the day of purchase. Do you have to pay this amount or do you receive it?
b. Compute the modified duration of the bond at the time of purchase.
c. In general, would a bond investor expecting a decrease in interest rates be likely to increase or decrease the duration of his/her bond portfolio? Explain.
6. Determine which of the following three bonds will change in price most as a response to a15 basis point increase in the yield and state the corresponding percentage change. What factor(s) seem(s) to determine the magnitude of the bond price change? Explain. (9 points)
- Bond A matures in 8 years 45 days, pays $43.5 every 6 months and currently trades at $ 875.15, and
- Bond B matures in 9 years 235 days, pays $73 annually and currently trades at$ 828.11,
- Bond C matures in 7 years and 140 days, carries a zero-coupon and currently trades at $630.23 (assume annual compounding intervals).
Part 3: Options
1. Assume the shares of the Wealth Corp. are currently trading at $84.25. The following 3-months options are available:
|
Option type
|
Exercise price
|
Option Premium
|
|
call
|
80
|
6.15
|
|
call
|
85
|
3.25
|
|
call
|
90
|
1.06
|
|
put
|
80
|
0.85
|
|
put
|
85
|
2.1
|
|
put
|
90
|
?
|
a. For each of the first five options, determine the intrinsic value and the speculative value.
b. What is the minimum premium you would expect for the put option with an exercise price of 90? Briefly explain.
c. Classify each option as either in-the-money, at-the-money, and out-of-the-money.
d. If you buy a put, what is you assumption about the future stock price? Briefly explain.
e. If you sell a call, what is your assumption about the future stock price? Briefly explain.
f. Draw the profit/loss diagram for the call with an exercise price of 90. Assume you are long the option.
g. Draw the profit/loss diagram for the put with an exercise price of 85. Assume you are short the option.
Part 4: Other Subject Areas
1. Explain the impact of debt on a long position. Be specific (you may want to a numerical example).
2. Describe the top-down approach to investing and explain under which circumstances this approach to international investing may not be suitable.