Major Paper: Assignment [20 marks] Q1. You have a portfolio of two bonds A and B.

Bond A is 1 Year bond with coupon rate of 8%. Bond B is 3 year Bond with coupon rate of 9%. The portfolio should bring you Rs. 3000000 after two year at expected yield of 10%. You are required to find a) the current price of the Bonds b) the duration of the Bonds c) the mix of A and B to immunize the portfolio d) the expected cash flow at the end of year 2 if yield rises at the end of year 1 by 2%.

A] Price of 1yr bond = 1080/(1+.10)1= 981.81 Time 1 2 3 DCF 90X1/1.1 = 81.81 90X1/(1.1)2 = 74.380 1090X1/ (1.1)3 = 818.93

PA

DCF X T 81.81 148.76 2456.79

PB = 975.12

2687.36

B] DA = 1 yr

DB = 2687.36/975.12 = 2.75 yr

of bond A = A1/PA = 1063636/981. of bond B = 1390908/975.c) conditions for immunization WADA + WBDB = DCOF WA.571 [WA + WB =1] Value of fund = 3000000/(1.2.429 WB = .1)2 = 2479338 (V0) Amount in bond A = A1 = V0 X WA = 1063636 Amount in bond B = A2 = V0 X WB = 1415701 No.75 = 1426 D] 10% Reinvestment proceeds of bond A 1080 (1+i) x NA YIELD at yr 1 12% 1309996 1286604 Income of bond B for 1st yr 90 (1+i)x NB For 2nd yr 141174 143740 .75 = 2 WA = .81 = 1083 No.1 + WB.

000 50 71 20 33 86 79 18 43 25 89 74 78 for 2 runs.7 . Financial Decision Analysis [40 marks] Q1. 00-19 20-79 CF P 35 .60 35 2digit no. Monte carlo simulation ( 000) Yr1 CF P 25 . With hypothetical figures of uncertain Cash flows of a project show how you will take your decision as to acceptability of the project based on different methods of appraisal. tables Initial investment = 70.20 80-99 Discounting factor @10% Random no..20 30 . .7 .57 128340 128340 1413036 2969154 2969879.2 45 50 .2 yr2 2digit no 00-09 10-79 80-99 CF P 30 .1 45 50 .90 x NB Sale proceeds 1090/ (1+i) x NB 1387803.57 Thus it is verified that it is immunized.1 yr3 2digit no 00-19 20-89 90-99 .

96 certainty equivalent 40 38 .RUN1 YR1 RN 50 CF 30 YR2 RN CF 71 45 YR3 RN 20 CF 45 30/1.1 + 45/ (1.1 + 50/(1.1)2 + 45/(1.78 (NPV) NPV is positive so accept the project. CERTAINTY EQUIVALENT METHOD YR 1 CF X P 4 15 7 YR2 CF X P 3 28 9 YR3 CF X P 5 28 5 Expected CF = 26 Certainty equivalent Coefficient: .90 .87 (NPV) 33 30 86 50 79 45 30/1.1)3 70 = 28.1)3 -70 = 31.1)2 + 45/(1.92 .

79 (NPV) . of course.79 70 = 8. is that if a tender is unsuccessful the company will have made a loss.1)3 =25.65 DCF = 79.228 70 = 9. These costs will have to be entirely recouped from the contract price.69 RADR RF = 8% K = 10% P = 4% RADR = K+P = 14% 26/(1+.1)2 =30.1 =22. The company has three options: y tender for MS1 only.778 38/(1+. or y tender for MS2 only. or y tender for both MS1 and MS2.14)3 = 25. . Accept the project 36. The risk. Problem --Your company is considering whether it should tender for two contracts (MS1 and MS2) on offer from a government department for the supply of certain components.228 (NPV).96 DCF 24.80 40/(1+.14) = 22.20/(1+. Accept the project.Cash flows 24.41 34.14)2 = 30.96/1+.8/(1+.20 34.8 36. If tenders are to be submitted the company will incur additional costs.69 DCF I = 78.

The component supply cost if the tender is successful would be £12.The cost of tendering for contract MS1 only is £50.000.000 0. .000. Should you accept her offer or not and why? Solution The decision tree for the problem is shown below. The cost of tendering for contract MS2 only is £14. possible tender prices have been determined. For each contract. subjective assessments have been made of the probability of getting the contract with a particular tender price as shown below. The cost of tendering for both contract MS1 and contract MS2 is £55.15 65. In addition.05 140.65 In the event that the company tenders for both MS1 and MS2 it will either win both contracts (at the price shown above) or no contract at all. submit two tenders (at different prices) for the same contract.000 0.000. for example. The component supply cost if the tender is successful would be £18. Note here that the company can only submit one tender and cannot.000 0.000.000 0. Option Possible Probability tender of getting prices (£) contract MS1 only 130.000 in cash she will ensure that if you tender £60.000 0.000 for contract MS2 only your tender is guaranteed to be successful. y What do you suggest the company should do and why? y What are the downside and the upside of your suggested course of action? y A consultant has approached your company with an offer that in return for £20.000 0.85 MS2 only 70.80 60.000.95 MS1 and MS2 190.000.000 0. The component supply cost if the tender is successful would be £24.20 115.

at a price of 130. total profit -50 y path to terminal node 14. we tender for MS1 only (cost 50). and lose the contract. at a price of 115. and lose the contract. and win the contract.Below we carry out step 1 of the decision tree solution procedure which (for this example) involves working out the total profit for each of the paths from the initial node to the terminal node (all figures in £'000). Step 1 y path to terminal node 12. total profit 115-50-18 = 47 y path to terminal node 15. and win the contract. we tender for MS1 only (cost 50). we tender for MS1 only (cost 50). total profit 130-50-18 = 62 y path to terminal node 13. at a price of 130. at a price of 115. we tender for MS1 only (cost 50). so incurring component supply costs of 18. so incurring component supply costs of 18. total profit -50 .

and win the contract. total profit -14 y path to terminal node 20. and win the contract. at a price of 70. and win the contract. and win the contract. at a price of 60.24=111 y path to terminal node 23. we tender for MS2 only (cost 14). and lose the contract. we tender for MS2 only (cost 14). and lose the contract. and win the contract. at a price of 65. at a price of 140. so incurring component supply costs of 12. and lose the contract. so incurring component supply costs of 24. at a price of 60. we tender for MS1 and MS2 (cost 55). we tender for MS1 and MS2 (cost 55). total profit -14 y path to terminal node 18. total profit 60-14-12 = 34 y path to terminal node 21. so incurring component supply costs of 24. we tender for MS2 only (cost 14). we tender for MS1 and MS2 (cost 55). so incurring component supply costs of 12. and lose the contract. we tender for MS2 only (cost 14). at a price of 70. we tender for MS2 only (cost 14). total profit 70-14-12 = 44 y path to terminal node 17.y path to terminal node 16. we tender for MS1 and MS2 (cost 55). so incurring component supply costs of 12. and lose the contract. Terminal node Total profit £'000 12 62 13 -50 14 47 15 -50 16 44 17 -14 18 39 19 -14 . total profit 140-55. at a price of 140. total profit -55 y path to terminal node 24. total profit -55 Hence we can arrive at the table below indicating for each branch the total profit involved in that branch from the initial node to the terminal node. at a price of 65. total profit -14 y path to terminal node 22. total profit 190-55. at a price of 190. at a price of 190. we tender for MS2 only (cost 14).24=61 y path to terminal node 25. total profit 65-14-12 = 39 y path to terminal node 19.

we could of course.8(-50) = -27.15(-50) = 32.05(111) + 0.7 y For chance node 11 the EMV is 0. With regard to the consultants offer then.65(61) + 0.15(44) + 0.45 y tender for MS2 only EMV=31.4 Hence the best decision is to tender for MS1 only (at a price of 115) as it has the highest expected monetary value of 32.45 (£'000).35(-55) = 20.4 y For chance node 9 the EMV is 0.2(62) + 0.6 Hence the best decision at decision node 3 is to tender at a price of 60 (EMV=31.85(47) + 0. y For chance node 7 the EMV is 0.3 y For chance node 8 the EMV is 0.45).20 21 22 23 24 25 34 -14 111 -55 61 -55 We can now carry out the second step of the decision tree solution procedure where we work from the right-hand side of the diagram back to the left-hand side. Step 2 y For chance node 5 the EMV is 0.95(-55) = -46.6). ignoring ethical considerations.45 Hence the best decision at decision node 2 is to tender at a price of 115 (EMV=32. Hence at decision node 1 have three alternatives: y tender for MS1 only EMV=32.4 Hence the best decision at decision node 4 is to tender at a price of 140 (EMV=20.4).20(-14) = 28. y For chance node 10 the EMV is 0.95(34) + 0.05(-14) = 31.6 y For chance node 6 the EMV is 0.85(-14) = -5. The downside is a loss of 50 and the upside is a profit of 47.6 y tender for both MS1 and MS2 EMV = 20. tender 60 for MS2 only without her help and if we were to do that we .80(39) + 0.

the downside of tendering unaided. Discuss on EIC Analysis.05 (one in twenty) does not seem like an awfully good investment and so we should reject her offer (or offer her a smaller sum of money in return for her guarantee!).would have a 0.95 probability of having our tender accepted. and considering tendering for MS2 only at 60. Looking at the risks (probabilities) of loosing money.05 chance of loosing 14.45. upside 47 (probability 0.05). Hence there are essentially three options: y as before. Paying 20 to guarantee not incurring a loss of 14 which will occur with a probability of 0. unaided by the consultant: EMV 31. with the consultants help. downside -14 (probability 0. Discuss the premises and methods of Technical Analysis and its usefulness in the context of efficiency of market 1] Economy-Industry-Company (EIC) Analysis . we would essentially be paying the consultant 20 to avoid a 0. then (assuming she can fulfil her promise of guaranteeing we will be successful). downside -50 (probability 0.85) y tender for MS2 only at a price of 60.6. Minor Papers: Assignment Security Analysis [20 marks] Q1. we have a certain outcome with a profit of 34 (terminal node 20) .95) y tender for MS2 only at a price of 60. [10] Q2.15).20 (cash paid to the consultant) = 14 On an EMV basis we would still support our original decision. tender for MS1 only at a price of 115: EMV 32. upside 34 (probability 0.

Prices Move in Trends: The concept of trend is absolutely essential to the technical approach. This action is the basis of all economic and fundamental forecasting. given the general trend of the economy and also an idea. psychologically. demand must exceed supply and the fundamentals must be bullish. the fundamentals must be bearish. If prices fall. In fact. ‡ History repeats itself. If supply exceeds demand. whether to invest or not in the given economic conditions. Thats why Economy analysis is important. most of the techniques used in this approach are trend-following in nature. The direction in which the economy is heading has a bearing on the performance of various industries. Market Action Discounts Everything: The statement "market action discounts everything" forms what is probably the cornerstone of technical analysis. in which the economy is heading. Chart patterns. The technician then turns this statement around to arrive at the conclusion that if prices are rising. If demand exceeds supply. that their intent is to identify and follow existing trends.In the Top down approach. prices should fall. for whatever specific reasons. ‡ Prices move in trends. or otherwiseis actually reflected in the price of that market. The output of the Economy analysis is a list of industries. Unless the full significance of this first premise is fully understood and accepted. 2] Three Premises of Technical Analysis There are three premises on which the technical approach is based: ‡ Market action discounts everything. first of all the overall Economy is analyzed to judge the general direction. prices should rise. meaning. The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. The technician believes that anything that can possible affect the price-fundamentally. The technician is claiming that price action should reflect shifts in supply and demand. that a study of price action is all that is required. therefore. for . politically. nothing else that follows makes much sense. It follows. History Repeats Itself: Much of the body of technical analysis and the study of market action has to do with the study of human psychology. which should perform well.

oscillators and momentum give a clearer picture of market action. 2] Individual stock analysis a) ‡ Trends ‡ Relationship between volume & trends ‡ Support & resistance levels b) Bar & line charts c) point & figure chart d) moving average analysis The Top Five Benefits of Technical Analysis Technical analysis involves the use of charts and technical indicators to predict the price movement of a currency. Many Forex traders use charting methods alone while others use a combination of approaches. when prices are trending. These pictures reveal the bullish or bearish psychology of the market. ‡ Technical analysis focuses on price movement. but that it also has limitations. technicians do not use economic reports that analyze the demand for a currency. Most traders know that technical analysis has its advantages and strong points. Let¶s examine the benefits of technical analysis. Since these patterns have worked well in the past. ‡ Trends are easily found. . Charts show how prices are moving (or not moving). And this information can be obtained at a glance. Volume. reflect certain pictures that appear on price charts. METHODS OF Technical Analysis 1] General market analysis a) Dow theory b) breadth of market analysis. which have been identified and categorized over the past one hundred years. it is assumed that they will continue to work well in the future.example. The primary focus of technical analysis is on the movement of prices. and the strength of those trends. Unlike fundamentalists. Many people (called technicians) swear by this approach to price forecasting while others (called fundamentalists) won¶t touch it.

Like star constellations. or sideways. down. Hence. and trading patterns appear quickly and easily. Charts show them clearly and quickly. Support and resistance levels are quickly identified. ‡ Patterns are easily identified. Charts and indicators can provide a huge amount of information in only a few moments. patterns can be complex and complicated.Taking a look at a moving average line quickly displays a price that is trending or stuck in a range. Head-and-shoulders patterns. Trends are critical to technicians because a currency is likely to continue moving in the direction of the trend. and double and triple tops are proven patterns that many currency prices will follow. It can be performed in less than five minutes and the services are very often offered for free or at a nominal cost. One of the basic tenets of market action is that it repeats itself in clear. ‡ Charting is quick and inexpensive. ‡ Charts provide a wealth of information. they have strong predictive powers. The Internet has a wealth of different technical indicators available that can help the trader to make more profitable and more reliable trades. . Trends are easily found. Computers have relieved us from the burden of performing complex mathematical operations. volatility. Whether it is up. Momentum. Using charts helps the trader to find patterns and predict price movements based on these patterns. a chart can quickly display a currency that is exhibiting a trend. This information is critical to technicians to make sound and profitable trades. ascending and descending triangles. They can be impossible to detect without using a chart. Technical analysis is less time consuming and less costly than fundamental analysis. There are more than fifty kinds of indicators and they each provide information on different aspect of how a currency is moving. unmistakable patterns. rounding tops and bottoms.