Q1

Ans.

Now we have the given data as following:

Current price per share of common (Po*) = 80
Expected dividend per share next year (DIV1) = 5
Constant annual dividend growth rate (g) = 7%
Risk free rate of return (rRF) = 6%
Return on market portfolio (rM) = 10%
Beta (βA) =?

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

Now putting the values, we get….

80 = 5/ {6% + (10% - 6%)* βA – 7%}

{(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.
Q2.
Ans.
Bond pricing formula:
PV  C1 /(1  rD)  C 2 /(1  rD) 2  C 3 /(1  rD ) 3  PAR /(1  rD) 3

Data is given as under:-

Coupon payment per annum = 2000*10%= 2000* 0.1 = 200

Required rate of return (rD) = 14% = 0.14
Par value or face value (PAR) = 2000
Maturity Period or Term = 3 Years
Bond Price (PV) =?

Putting the values:

PV = 200 /(1  0.14)  200 /(1  0.14) 2  200 /(1  0.14) 3  2000 /(1  0.14) 3
PV = (200/1.14) + (200/ 1.2996) + (200/1.4815) + (2000/ 1.4815)
PV = 175.4386 + 153.8935 + 134.9983 + 1349.9831
PV = 1814.3135 (Bond A)
The interest rate is directly proportional to the bond price. If the interest rate is high, the
bond price falls and vice versa. The longer the maturity period, the higher will be the
interest rate risk. So, ABC should purchase bond A having the shorter maturity period
than