Assignment
Problem I
a. Binary Boards Corporation (BBC) has a growing reputation on the London Stock Market. Research into the 2017/18 company accounts and extensive discussions with market analysts about the BBC has come up with the following information about the company:
i) ROE = 19%
ii) Beta = 0.9
iii) Last year's EPS = £9.70
iv) The BBC board plans to maintain their traditional plowback ratio of 2/3
The BBC have just paid their annual dividend and the market consensus is that the 2018/19 market return should be 24% with a current T-bill offering 4% remaining unchanged over this period. Calculate the selling price of BBC stock using the above information.
b. Inter Tyre Valves (ITV) has 400 million ordinary shares in issue. Each share has a par value of €1 and the company recently paid an ordinary dividend amounting to €80 million in total. Ordinary shareholders have a required return of 12%.
Based on this information, provide an estimate of the market price per ordinary share in ITV. Briefly describe at least two assumptions underlying your answer.
c. The equity section of the balance sheet for Yorkie Steels Ltd (YSL) looks like this:
Common stock, $0.35 par $630,000
Paid-in capital surplus $5,500,000
Retained earnings $1,500,000
Calculate the number of shares the company has issued along with the book value per share. Assume that YSL has made only one offering of common stock, at what price did it sell shares to the market for?
d. If a company has a Cost of Debt = 6%, a Cost of equity = 12.1% and has a debt/equity ratio of 40%. Calculate the after-tax weighted average cost of capital (WACC) given the current corporation tax rate is sitting at 19%.
e. You have seen the following statement in a guide to international investing:
‘When considering an international investment it is important to take into account the market size, trading volume and concentration of the underlying stock market.'
Discuss the importance of stock market micro-structure when choosing appropriate assets to hold within an international portfolio. Your answer should describe key elements of market structure which you think should influence any decisions. Do you agree or disagree with this statement? Note: Your answer should discuss reasons for your opinion with reference to an ideal market structure and should be supported by examples.
Problem 2
I.
The spot rates of interest for five U.S. Treasury securities are shown in the following table
|
Term of maturity (year)
|
SPOT rate of interest( %)
|
|
1
|
13
|
|
2
|
12
|
|
3
|
11
|
|
4
|
10
|
|
5
|
9
|
a. Compute the 2-year implied forward rate for a deferred loan beginning in 3 years (default-free). What theory is your calculations based on?
b. Compute the price of a 5-year Treasury security with a coupon rate of 9% by using the information in the table above.
c. Briefly explain why bonds of different maturities have different yields in terms of the expectations as well as the liquidity preference hypotheses. Use this example of the yield curve to describe the implications of each hypothesis.
II.
A £100 par value bond with 4 years to maturity and a 10 percent coupon has a yield to maturity of 9 percent. Interest is paid semi-annually.
a. Use the duration rule to estimate the percentage price change for this bond, if the yield increases by 150 basis points. Why is this estimate likely to be an inaccurate measure of the actual change in the bond's value? Support your answer with calculations
Problem 3
I.
a. Assume that you have 100 shares of FinCorp stock which has a volatility of 25% and a current stock price of £80 per share. FinCorp pays no dividends. The risk-free interest rate is 3%. Use the Black-Scholes option pricing model to value a six-month, at-the-money European call option on FinCorp stock. What action should you take to hedge using call options? What would be the total value of this transaction?
II.
You are thinking to formulate an investment strategy. On the one hand, you believe that there is great upward potential in the stock market. On the other hand, you want to avoid downside risk which you think is also possible. You come up with two investment strategies as follows,
o Portfolio A: Buy both shares in a market index stock fund and put options on those shares with 3-month expiration and exercise price of £1,170. The stock index fund is currently selling for £1,350.
o Portfolio B: Buy a 3-month call option on the stock index fund with exercise price £1,260 and buy 3-month T-bills with face value £1,260.
In addition, suppose the market prices of the securities are as follows,
|
Stock fund
|
1,250
|
|
T bill (face value 1,260)
|
1,215
|
|
Call (exercise price 1,260)
|
180
|
|
Put (exercise price 1170)
|
9
|
a. Draw the profit diagram for both portfolios as a function of the stock price at expiration. What are the profits realised for each portfolio for the following values of the stock price in 3 months: £1,000, £1,350, £1,440?
b. Which strategy is riskier? Which should have a higher beta?
c. Briefly explain why the data for the securities (in the table above) do not violate the put-call parity relationship.
d. What are the trade-offs facing an investor who is considering buying a put option on an existing portfolio (like Portfolio 1)? Explain briefly.
Format your assignment according to the give formatting requirements:
a. The answer must be double spaced, typed, using Times New Roman font (size 12), with one-inch margins on all sides.
b. The response also includes a cover page containing the title of the assignment, the course title, the student's name, and the date. The cover page is not included in the required page length.
c. Also include a reference page. The references and Citations should follow APA format. The reference page is not included in the required page length.