Financial Institutions Winter Assignment 3

It is an individual assignment. (33 marks)

Bond:

Bond:

1. T bills. The 91-day T bill has a yield of 0.5%. Suppose the face value is $100. What is the
purchasing price? (keep 4 decimals)
The annualized T-bill has annual yield is 0.5%. It is yield is the 91 day period is
0.5%*91/365=0.1247%.
F−P
=0.1247 %
P
F
−1=0.1247 %
P
100
=1+ 0.1247 %
P
100
P= =$ 99.8755
1+0.1247 %

2. Bond Duration: What is the duration of a bond with 7% discount rate, 3-year maturity, and 10%
coupon paid annually?
3. Accrued interest: If there are 183 days between interest settlement dates and it is 50 days since
the last payment. The coupon rate is 3.5%. The quoted price is $950. The face value is $1000.
What is the clean price? What is the accrued interest? What is the price that investors pay?

(1) Clean price=quoted price=$950

(2) Accrued interest= ($1000*3.5%/2)* 50/183=4.78
(3) Price you pay=dirty price=clean price + accrued interest=950+4.78=954.78
4. Bond return: Each semi-annual coupon is $40. In half a year, price increases from
$950 to $1000. a) what is the capital gain yield? b) what is the income yield? c) what
is the holding period return in this half a year?
(1) The capital gain yield=(1000-950)/950=5.26 percent
(2) The income yield=40/950=4.21 percent
(3) Holding period return=capital gain yield + income yield=5.26%+4.21%=9.47%.
Fixed Income:

5. Consider a bond with a 7 percent semi-annual coupon and a face value of $1000. Complete the
following table. Note that yield to maturity is quoted annually. Describe the relation between
bond price and yield to maturity.

Solution:

years yield to maturity Price

3 5.00% $1,055.08
3 7.00% $1,000.00
6 7.00% $1,000.00
9 8.00% $936.70
9 7.78% 950

When yield to maturity is above the coupon rate, the band’s current price is below its
face value. The opposite holds true when yield to maturity is below the coupon rate. For a given
maturity, the bond’s current price falls as yield to maturity rises. For a given yield to maturity, a
bond’s value rises as its maturity increases. When yield to maturity equals the coupon rate, a
bond’s current price equals its face value regardless of years to maturity.

Equity:

6. Dividend at present is $2, equity cost is 8%, and growth rate is 5%. What is the equity price? (2
marks)
P0=D0*(1+g)/(k-g)=2*(1+5%)/(8%-5%)=70

7. Margin account

Maximum margin example

i. p>=$2: 50% margin loan(brokerage can lend money which equals 50% of
security)
ii. $1.75<=P<$2: 40% margin loan
iii. $1.50<=P<$1.75: 20% Margin loan
iv. P<$1.50: No margin loan

Client buys 1,000 shares of ABC on margin at $1.95

(1) If stock price rises to $3. How much money does the client make? (2 marks)

How much money does the client make =1000*(3-1.95)=1050

(2) If the stock price falls to $1.8. How much money does the client lose? Dose it trigger a margin call?
How much money should the client put into the client if there is a margin call? (2 marks for each
question)

Lose 1000*(1.95-1.8)=150.

Client buys 1,000 shares of ABC on margin at $1.95

Cost: $1,950

Margin loan @ 40%: 780

Margin: ie., cash put up by client: $1,170

If price falls to $1.80

New Value: $1,800

Margin Loan @ 40%: 720

Current equity: =1170-1000*(1.95-1.8)=1020

Margin Call, ie., extra cash needed $ 1800-720-1020=60

8. short-selling.

• P>$2 150% of market value

• Increasing amounts for lower valued shares

• Client wants to sell 1,000 shares of ABC at $5

(1) what is the minimum margin required?

(1) if the stock price increases to $6, how much money should the client put into the account? (2 marks)

Client wants to sell 1,000 shares of ABC at $5

Minimum account balance needed (150%) $7,500

Proceeds from short sale: 5,000

Minimum margin required: 2,500

If ABC’s price increases to $6

Minimum balance needed: 1000*6*150%=9000

Proceeds from short sale: 5,000

Minimum Margin needed: 4,000

Amount deposited: 2,500

Margin Call: 1,500

(2) if the stock price drops to $4 from $5, how much money does the client make or lose? (2 marks)

=1000*(5-4)=1000 . The client makes $1000

9. The average industry PE ratio for retail companies is 20. Amazon’s own PE ratio is 73.27. What is
the estimated price of Amazon if earnings per share are projected to be $24 by using the
comparables method? (2 marks)
P=20*24=$480.