MGT201 ASSIGNMENT # SOLUTION

THIS IS JUST IDEA

Question stock beta#1

Vu handout page#105

Average Required ROR for all rational investors in an Efficient Market can be estimated using the CAPM Theory: Beta and Risk Free Rate of Return.

Total Rate of Return (ROR) for Single Stock = Dividend Yield + Capital Gain. GORDON’S FORMULA FOR COMMON STOCK PRICING OR VALUATION USES REQUIRED RETURN r = DIV/Po + g. In Efficient Markets, Price of Stocks is based on Market Risk (or Beta). We can formulate the required rate of return in terms of Beta risk so how can we use beta coefficient to calculate the required rate of return for the average investor in the market. The answer to it is the

Vu handout page # 114

Po* = DIV1 / [ (rRF + (rM - rRF ) βA ) - g]

Where

Po*=80

DIV1= 5

g= 7%

rRF = 6%

rM = 10%

βA ) ?

Now put the values and get answer which is = βA 1.8125

Question#2

Bond valuation

Bond Pricing Equation: Vu handout page#123

Bond Price = PV = C1/ (1+rD) + C2/ (1+rD) t2+ C3 / (1+rD)t3 + ….. + PAR / (1+rD)n3

Where

Pv = bound value

C= coupon payment Pa = 2000*10.100= 200

rD= required rate of return = 14%=0.14

PAR = par value or face value= 2000

Maturity period

Bound A = t 3 n3

Bound B = t 5 n5

Answer:

(a)Bond A = value Rs: 1967

(b)Bound B= value Rs: 1928

(b)Interest rate risk

Definition

The possibility of a reduction in the value of a security, especially a bond, resulting from a rise in interest rates. This risk can be reduced by diversifying the durations of the fixed-income investments that are held at a given time.

According to LAWARENCE J. GITMAN 12th EDITION FINANCIAL MANAGEMENT interest rate risk is the market interest rate fluctuation that directly affect the bound s value that have constant coupon payment, to reduce the fear of market interest risk diversify the portfolio as it can be spread and chose the bound with shorter duration……

So bound B is perfect decision having the shorter maturity period than bond A

Po* = DIV1 / {rRF + (rM - rRF) * βA – g}

80 = 5/ {6% + (10% - 6%)* βA – 7%}

80 = 5/ {6% + (4%)* βA – 7%}

80 = 5/ {(4%)* βA – 1%}

{(4%)* βA – 1%}*80 = 5

{(4%)* βA – 1%} = 5/80 = 0.0625

(4%)* βA = 0.0625 + 1% = 0.0625 + 0.01 = 0.0725

βA = 0.0725/4% = 0.0725/ 0.04 = 1.8125 Ans

THIS IS JUST IDEA

Question stock beta#1

Vu handout page#105

Average Required ROR for all rational investors in an Efficient Market can be estimated using the CAPM Theory: Beta and Risk Free Rate of Return.

Total Rate of Return (ROR) for Single Stock = Dividend Yield + Capital Gain. GORDON’S FORMULA FOR COMMON STOCK PRICING OR VALUATION USES REQUIRED RETURN r = DIV/Po + g. In Efficient Markets, Price of Stocks is based on Market Risk (or Beta). We can formulate the required rate of return in terms of Beta risk so how can we use beta coefficient to calculate the required rate of return for the average investor in the market. The answer to it is the

Vu handout page # 114

Po* = DIV1 / [ (rRF + (rM - rRF ) βA ) - g]

Where

Po*=80

DIV1= 5

g= 7%

rRF = 6%

rM = 10%

βA ) ?

Now put the values and get answer which is = βA 1.8125

Question#2

Bond valuation

Bond Pricing Equation: Vu handout page#123

Bond Price = PV = C1/ (1+rD) + C2/ (1+rD) t2+ C3 / (1+rD)t3 + ….. + PAR / (1+rD)n3

Where

Pv = bound value

C= coupon payment Pa = 2000*10.100= 200

rD= required rate of return = 14%=0.14

PAR = par value or face value= 2000

Maturity period

Bound A = t 3 n3

Bound B = t 5 n5

Answer:

(a)Bond A = value Rs: 1967

(b)Bound B= value Rs: 1928

(b)Interest rate risk

Definition

The possibility of a reduction in the value of a security, especially a bond, resulting from a rise in interest rates. This risk can be reduced by diversifying the durations of the fixed-income investments that are held at a given time.

According to LAWARENCE J. GITMAN 12th EDITION FINANCIAL MANAGEMENT interest rate risk is the market interest rate fluctuation that directly affect the bound s value that have constant coupon payment, to reduce the fear of market interest risk diversify the portfolio as it can be spread and chose the bound with shorter duration……

So bound B is perfect decision having the shorter maturity period than bond A

Po* = DIV1 / {rRF + (rM - rRF) * βA – g}

80 = 5/ {6% + (10% - 6%)* βA – 7%}

80 = 5/ {6% + (4%)* βA – 7%}

80 = 5/ {(4%)* βA – 1%}

{(4%)* βA – 1%}*80 = 5

{(4%)* βA – 1%} = 5/80 = 0.0625

(4%)* βA = 0.0625 + 1% = 0.0625 + 0.01 = 0.0725

βA = 0.0725/4% = 0.0725/ 0.04 = 1.8125 Ans