finance assignment
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ASSIGNMENT #2
The purpose of this assignment is to solidify your understanding on the applications of the risk
and return concepts and their role in valuing financial assets. The scores of this assignment will
help in assessing the following learning goal of the course: “students successfully completing
this course will be able to Analyze risk return characteristics to assess valuation of financial
assets”.
Instructions:
You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems
(provided on page 3) related to the risk and return, stocks and bonds valuation. You are required
to show the following 3 steps for each problem (sample questions and solutions are provided for
guidance):
(i) Describe and interpret the assumptions related to the problem.
(ii) Apply the appropriate mathematical model to solve the problem.
(iii) Calculate the correct solution to the problem.
Sample Questions and Solutions
Sample Question # 1: A company has an issue of 12-year bonds that pay 5% interest, annually. Further assume that today's required rate of return on these bonds is 7%. How much would these bonds sell for today? Round off to the nearest $1. Solution
(i) The problem assumes that the face value of the bond is $1000. The bond will pay an annual coupon of 5% i.e., coupon or interest amount of $50 is assumed to paid every year. It also assumes that investors currently required a return of 7% on investments with similar risk characteristics. The use of bond valuation concept is appropriate to calculate the true value of these bonds. The accuracy of the solution depends on the correctness of the assumptions on face value, coupon payments and required rate of return assumption.
(ii) The use of bond valuation concept which suggests that the true value of a bond is the present value of its future coupon and face value discounted at investors required rate of return is appropriate to calculate the true value of these bonds. We are required to compute the present value (PV) which represents the true value of the bond.
(iii) FV= $1000; PMT=$50; Rate = 7%; N=12 years; Compute PV = ? $841.15
Value of the Bond = $841.15
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Sample Question # 2: A company just paid a dividend of $1, and the dividends are expected to grow at constant rate of 4% forever. If the required return of the stockholders is 12%, what is the price of this company’s stock? Solution
(i) The problem assumes the stock will have a constant growth of 4% forever. The constant growth model is appropriate to use for this problem. The accuracy of the solution depends on the correctness of the constant growth assumption.
(ii) The constant growth model is given as: P0 = D1/ (R-g); where • P0 is the current price to be calculated, • D1 is the next period’s dividend, • R is the required return on this stock • g is the constant growth
D1 needs to be calculated in order to apply this model.
(iii) D1= 1x(1+0.04) = 1.04 P0 = 1.04 /(0.12-0.04) = $13; the stock price should be $13 based on the constant growth model.
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Assignment Problems
1. ABC Corporation issues a bond which has a coupon rate of 10.20%, a yield to maturity of 10.55%, a face value of $1,000, and a market price of $850. What is the annual interest payment?
2. A shipping company sold an issue of 12-year $1,000 par bonds to build new ships. The bonds pay 4.85% interest, semiannually. Today's required rate of return is 9.7%. How much should these bonds sell for today? Round off to the nearest $1.
3. Assume a company has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually. Further assume that today's required rate of return on these bonds is 5%. How much would these bonds sell for today? Round off to the nearest $1.
4. ABC company issued bonds on January 1, 2006. The bonds had a coupon rate of 5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January 1, 2021. What is the yield to maturity for these bonds on January 1, 2012 if the market price of the bond on that date is $950?
5. A $1,000 par value 14-year bond with a 10 percent coupon rate recently sold for $965. What is the yield to maturity?
6. Consider a 10 year bond with face value $1,000, pays 6% coupon semi-annually and has a yield-to-maturity of 7%. How much would the approximate percentage change in the price of bond if interest rate in the economy decreases by 0.80% per year?
7. ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for the foreseeable future. What is the value of the stock to an investor with a required return of 12%?
8. ABC Company's common stock is expected to pay a $2.00 dividend in the coming year. If investors require a 17% return and the growth rate in dividends is expected to be 8%, what will the market price of the stock be?
9. ABC Corporation stock is currently selling for $58.00. It is expected to pay a dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant rate of 7.5% indefinitely. Compute the required rate of return on ABC Corporation stock.
10. XYZ Corp. paid a dividend today of $5 per share. The dividend is expected to grow at a constant rate of 6.5% per year. If XYZ Corp. stock is selling for $50.00 per share, what is the stockholders' expected rate of return?
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Grading Rubric
Learning Objective Subcomponent Not Submitted 0
Does Not Meet Expectations
1
Meets expectations
2
Exceeds Expectations 3
LO#2: Analyze risk return characteristics to assess valuation of financial assets.
The student will make and evaluate important assumptions in identification of appropriate asset valuation variables and risk and return measures
No attempt made Attempts to describe assumptions
Explicitly describes assumptions
Explicitly describes assumptions and provides rationale for why each assumption is appropriate. Show awareness that confidence in final conclusions is limited by the accuracy of the assumptions (e.g., provides descriptions about the assumptions of the model and its limitations; lists and describes each variable within the model)
The student will convert relevant information into various mathematical forms (e.g., equations, graphs, words)
No attempt made Completes conversion of information but resulting mathematical portrayal is inappropriate or inaccurate
Completes conversion of information into mathematical portrayal
Relevant information is expressed in an insightful mathematical portrayal in a way that contributes to a further or deeper understanding (e.g., correct variables are selected and the mathematical model is portrayed with the correct variables)
The student will calculate risk and return measures and asset values
No attempt made Calculations are attempted but are both unsuccessful and not comprehensive
Calculations are attempted to solve the problem but not comprehensive
Calculations attempted are essentially all successful and sufficiently comprehensive to solve the problem. Calculations are also presented elegantly (e.g., provides insights on the interpretation of the calculated value of an asset such as the value of a stock is valid only within the context of the model and its limitations)
The above rubric will be applied to grade each question and the average score will be calculated for each subcomponent.