Name MUQADDAS ZUBAIR

Roll No# 32

Security Analysis & Portfolio Management

Assignment # 2

Question 1

Given a required return of 6%, how much you would be willing to pay for a semi-
annual-pay bond with an 8% pa coupon rate, a $1,000 face value, and 15 years
remaining to maturity? The next coupon is due six months from now.

Answer bcz semi-annually so we divided by 2

Required rate of return =6% ÷2=0.03 FV=1000

Coupon rate=8% ÷2=0.04 N=15 ×2=30
Pmt=8% ×1000÷2=40

Here the formula of value of bond is

PMT

1- 1
(1+i)^n + FV
i (1+i)^n

40 1- 1
(1+0.03)*^30 + 1000
0.03 (1+0.03)^30

Total present value of the bond at 6%= 40 × 19.600 + 411.98

Price of bond =1195.98
The price of a bond is more from its face value so bond will sell at premium
Question 2 You are pricing a 10-year, 6 percent coupon bond with a $1,000 face
value. Coupon payments are made semi-annually, and the first payment is due in
exactly six months.

(a) You have researched other semi-annual pay bonds of similar maturity and
credit quality and determine that the appropriate yield to maturity is 5 percent.
Using this as the required rate of return, compute a fair value for this bond.

(b) Now assume that the required yield to maturity is 7%. Calculate the bond price
again.

(c) What is the relationship between bond’s price, par value and yield to maturity?

Answer

Part (a)

Required rate of return =5% ÷2=2.25% FV=1000

Coupon rate=6% ÷2=0.03 N=10 ×2=20
Here the formula of value of bond is
PMT

1- 1
(1+i)^n + FV
i (1+i)^n

30 1- 1

(1+0.025)^20 + 1000

0.025 (1+0.025)^20

Bond valuation = 30 × 15.588+610.2276

Total present value of the bond at 5%= 477.67+610.00 = 1080

The bond will sell at premium

Part (b) Now assume that the required yield to maturity is 7%. Calculate the bond
price again.

Answer

Required rate of return =7% ÷2=3.5% FV=1000

Coupon rate=6% ÷2=0.03 N=10 ×2=20

30 1- 1

(1+0.035)^20 + 1000

0.035 (1+0.035)^20

30 1- 1

1.980788863 + 1000

0.035 1.980788863

Bond valuation = 425.37 + 503

Total present value of the bond at 7% =920.55

The bond will sell at discount because bond price is less from is face value

(c) What is the relationship between bond’s price, par value and yield to
maturity?

A bond's price moves inversely with its YTM. An increase in YTM decreases the price and a
decrease in YTM increases the price of a bond. The relationship between a bond's price and
its YTM is convex. Percentage price change is more when discount rate goes down than
when it goes up by the same amount. The par value of a bond is the price at which the bond is sold
to investors when first issued; it is also the price at which the bond is redeemed at maturity
Question 3

Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $2.35 next
year. The growth rate in dividends for all three companies is 5 percent. The
required return for each company’s stock is 8 percent, 11 percent, and 14 percent,
respectively. What is the stock price for each company? What do you conclude
about the relationship between the required return and the stock price?

Answer We can use the constant dividend growth model, which is:

P t = D1/ (R – g)

So, the price of each company’s stock today is:

 Red stock price = $2.35 / (.08 – .05) = $78.33

 Yellow stock price = $2.35 / (.11 – .05) = $39.17

 Blue stock price = $2.35 / (.14 – .05) = $26.11

As the required return increases, the stock price decreases. This is a function
of the time value of money: A higher discount rate decreases the present
value of cash flows.
Question 4

Suppose the risk-free rate is 8 percent. The expected return on the market is 16
percent. If a stock has a beta of .7, what is its expected return based on the CAPM?

Answer

Risk-free rate = 8% expected return on the market = 16%

Beta = .7 expected return ?

Here the formula is to be determining the Expected rate of return for a risky asset

E(R) = RFR+B [E(RM) – RFR]

E(R) = 0.08 + .7(0.16 – 0.08) = 0.08 + 0.056

E(R) = 0.136 =13.6%

If another stock has an expected return of 24 percent, what must its beta be?

E(R) = RFR + B [E(RM) – RFR]

24% = 0.08 + B (0.16 – 0.08)

24% - 0.08 = B (0.08)

0.16 = B

0.08

SO, the beta is = 2

BY checking the answer

E(R) = 0.08 + 2 (0.16 – 0.08)

E(R) = 24%
5 : Define the combination of Risk-Free Assets and Risky Portfolios on
Efficient Frontier?

Any point below A is dominated by the RFR. In fact the entire efficient frontier
below M is dominated by points in the RFR-M line(combinations obtained by
investing a part of the portfolio in the risk free asset and the remainder in M) For
example , considering points P Nd B that have the same level of risk, p dominated
the previously efficient B because it has higher return for the same level of risk

As shown, M is at the point where the ray from RFR is tangent to the efficient
frontier . The new efficient frontier thus become RFR M-F.

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