FIN630 VU Current Assignment No. 2 Fall 2011 Last date 13 Jan 2012

[Vuhelper]

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Mr. Asad is considering two available securities in market for investment. He is rational investor and wants to analyze both securities on the basis of fundamentals.

Being a financial analyst you are required to help Mr. Asad in evaluating and selecting one of the securities. Following are two investment options:

1. Multiline Insurance Company issued Rs. 1,000 par value 15%, 5-year bond.

Bond is issued at premium with annual coupon payments. Required rate of return for such type of securities is 12%. Return on T-bills is 10%. Rating of Multiline Insurance Company for the current year is BB. Bond is currently trading at Rs. 855.

2. IRA Foods and Beverages shares are selling at Rs. 95 per share and company is paying Rs. 8 per share dividend which is expected to grow at 6% for the foreseeable future. Dividend payout ratio of snow the company is higher as compared to the other companies in the industry. Trading history of the company’s shares on KSE shows an increased demand for the shares.

Investors required rate of return for such type of investment is 14%.



Required:

A. Calculate intrinsic value of Multiline Insurance Company’s bond. (4 Marks)

B. Calculate intrinsic value of IRA Foods and Beverages’ stock using Dividend

Discount Model. (4 Marks)

C. On the basis of intrinsic value, which security Mr. Asad should select? Give logical reasoning to support selection. (2Marks)

D. Due to political instability in the country, investors demand higher risk premium that has increased required rate of return of investors to 16% for both securities. What will be intrinsic value of bond and share due to change in required rate of return? (4+4 Marks)

E. What is the volatility/percentage price change of bond due to increase in required rate of return from 12% – 16%. What does it show? (4 Marks)

F. If it is assumed that Mr. Asad is not willing to take risk and decides to invest in fixed income security, calculate duration of fixed income security. (8 Marks)

Note: Show complete step-wise working along with formulae; otherwise marks will be deducted).



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SEMESTER FALL 2011

Investment Analysis & Portfolio management (FIN 630)

Assignment No.02

Due Date: January13, 2012 Marks: 30



Instructions:

Only in the case of Assignment, 24 hours extra / grace period after the due date is usually available to overcome uploading difficulties which may be faced by the students on last date. This extra time should only be used to meet the emergencies and above mentioned due dates should always be treated as final to avoid any inconvenience.

Other Important Instructions:

Deadline:

• Make sure to upload the solution file before the due date on VULMS.

• Any submission made via email after the due date will not be accepted.



Formatting guidelines:

• Use the font style “Times New Roman” or “Arial” and font size “12”.

• It is advised to compose your document in MS-Word format.

• You may also compose your assignment in Open Office format.

• Use black and blue font colors only.



Solution guidelines:

• Every student will work individually and has to write in the form of an analytical assignment.

• Give the answer according to question, there will be negative marking for irrelevant material.

• For acquiring the relevant knowledge do not rely only on handouts but watch the video lectures and use other reference books also.



Rules for Marking

Please note that your assignment will not be graded or graded as Zero (0), if:

• It is submitted after the due date.

• The file you uploaded does not open or is corrupt.

• It is in any format other than MS-Word or Open Office; e.g. Excel, PowerPoint, PDF etc.

• It is cheated or copied from other students, internet, books, journals etc.

[Vuhelper]

CHAPTER 5: HOW TO VALUE BONDS AND STOCKS
(Assigned problems are 1, 4, 5, 7, 8, 9, 13, 16, 17, 18, 21, 22, 23, 25, 26, 29, 31, and 33. Omit
the Appendix to this chapter). This notes package contains two Addendums.
I. BOND VALUATION
Bonds are “Fixed Income” securities, since the cash flows that the bondholder will
receive have been fixed or prespecified in the bond contract.
The current fundamental or intrinsic value of a bond (or any other financial asset)
is equal to the Present Value or PV0 of all future expected cash flows.1
An investor’s actual return on a bond, for any holding period, comes in two forms:
(1) the coupon yield (from the payment of coupon interest)
(2) the capital gain (bond’s change in price)
Zero Coupon Bonds: a zero coupon bond will pay its stated face or par value
at maturity. It pays no other future cash flows during its life. Zeroes are al