Q1. Portfolio Valuation
In Week 5 lecture slides, you may have noted the use of Yahoo7!Finance (https://au.finance.yahoo.com/) to determine share prices and dividends for BHP Billiton Ltd and Commonwealth Bank of Australia for particular dates. In Week 3, you have come across the idea of portfolio. In this case study, you will gain experience of using the knowledge from both weeks in solving a practical problem.
Assume that you are acting as financial advisor for a firm. You have a client who wants your advice regarding the development of a two-asset portfolio. The client has $10,000 to invest. You have thought of two different investment choices the client can make:
Choice 1:
Invest $6000 in the shares of Greencross Ltd (listing code: GXL.AX) and $4000 in the shares of Commonwealth Bank of Australia (listing code: CBA.AX).
Choice 2:
Invest $4000 in the shares of Commonwealth Bank of Australia (listing code: CBA.AX) and $6000 in the shares of Myer Holdings Ltd (listing code: MYR.AX).
For decisions like this, you also need to know the expected return from the assets (i.e., shares). In this case, assume that the expected return for a companyâs share is the same as the holding period return of that share over the period 1 Mar 2016 â 1 Mar 2017. For this math, the holding period returns are to be calculated based upon the prices indicated under the âcloseâ column at the Yahoo!7 Finance website for these two dates and the dividends attained between these two dates.
(In other words, please assume that an investor buys the share of a company on 1 Mar 2016 at the price equal to the âclosing priceâ for that date; and then sells the share on 1 Mar 2017 at the price equal to the âclosing priceâ for that date. Please also consider all dividends paid between these two dates. The holding period return based upon this purchase price, selling price and total dividends received is then also regarded as the expected return for that company's share.)
(a) Calculate the expected return of the portfolio for both investment choices.
(b) Suppose, you are also given the following (hypothetical) information
Share Standard deviation of return Correlation coefficient of return between GXL and CBA Correlation coefficient of return between CBA and MYR
GXL 0.125 0.80 0.55
CBA 0.256
MYR 0.586
Which of the investment choices (i.e., choice 1 or choice 2) entail the least risk, when considering the standard deviation of return from the two-asset portfolio as the measure of risk?
Q2. Bond Valuation
Suppose an investor is considering investment in the following three bonds:
Bond A:
This is a coupon bond that has a face value of $1000 and coupon rate of 5% paid quarterly. The bond matures in 10 years.
Bond B:
This is another coupon bond, which also has a face value of $1000 and coupon rate of 5% paid annually. This bond matures in 10 years.
Bond C:
This is a zero-coupon bond, which also has a face value of $1000. It also matures in 10 years. Interest is compounded quarterly.
Suppose, the investor evaluates the bonds for the following sets of market interest rates (i.e., i in the Bond formula):
3.5%
5%
10.0%
Given the above information:
Discuss how the prices for these bonds change with the market interest rate. In your discussion, also indicate whether there is any difference between the bonds in respect to these changes of price, especially due to the differences among these bonds regarding coupon rate and compounding. Further, indicate how such differences among the bonds and the changes in market interest rate may relate to an investor's investment decision.
[INSTRUCTION: You are to determine prices of the bonds for each of the different market interest rates, and then discuss. For discussions, you are to cite at least 3 relevant references including the textbook. The other references can be any web based reference/textbook/journals/articles or other resources. Please also note the discussions within the section entitled âInterest Rate Riskâ in the book, which may assist in responding to this question. You may also plot a figure similar to Figure 8.3 to substantiate your discussion. No word limit for the discussion part; though maximum 250 words is reasonable.]
Q3. Loan Valuation
Suppose a term loan involves borrowing $50,000 now, and which will be repaid through equal semi-annual payments over 2 years. The quoted rate of interest is 7% p.a., compounded semi-annually.
i. Calculate the annual payments and show the amortization schedule for the term loan.
ii. Calculate the effective annual interest rate for the term loan.
Q4. Share Valuation
An investor is evaluating three different securities as potential investment:
Security A:
This is the preference share of MXM Ltd. The security pays a $2.50 dividend every year, in perpetuity. The investorâs required rate of return for this security is 10% p.a. The security is currently selling in the market at $20.
Security B:
This is the ordinary share of ABM Ltd. The security is expected to pay a dividend of $4 per share next year. It is also expected that the dividends will continue to grow at a constant rate of 5%. The investorâs required rate of return for this security is 17% p.a. The security is currently selling in the market at $40.
Security C:
This is the ordinary share of BMB Ltd, a fast-growing company. The company expects to grow at a rate of 20% in the first three years, and then by 10% for the next two years. Followed by this, the company is expected to settle to a constant growth rate of 4%. The first dividend is expected two years from now and it will equal $5. The investorâs required rate of return for this security is 20% p.a. The security is currently selling in the market at $25.
Given the above information:
(a) Determine the proper price (i.e., value) of all the three securities given the investorâs required rates of return.
(b) Given the market prices and considering the calculation in (a), outline (for each of the securities) whether the securities are desirable purchase or not?
(c) Suppose the ABM Ltd. in the question above is a multi-national corporation, involved in doing business across multiple countries. What factors in the local and global market, do you think, may impact the expected dividend and growth, and consequently its share price?
[This is a conceptual question, designed to encourage you to think and do a bit of research on share valuation relevant topics (further to that indicated in the book). No specific word limit. However, the recommended maximum word length is about 250 words. No mark deduction if you go over a bit. You are to cite at least 3 relevant references. The references can be any web based reference/textbook/journals/articles or other resources. The grading will consider, further to the content, the critical thinking capacity demonstrated in the response and the presentation style.]