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University University Of Stirling (US)
Subject Introduction To Finance

A. MINI CASE_BONDS

The management of a construction company is considering issuing a 5-year bond to finance its future investment projects in Dubai. However, all members of the BoD are civil engineers and have very vague and sporadic knowledge of finance. You are hired by the firm to act as a financial advisor.

Q1. Explain to the manager of the firm the obligations of a bond issuer.
Currently, the economy is experiencing a positive business cycle and the management believes that the time is perfect for the issue of the bond.

Q2. (i). Explain the management the risks and opportunities given contemporary business conditions. What is your advice to the firm?

(ii). How demand and supply bond curves react under these conditions?

Q3. (i). How is the value of a bond determined?

(ii). Which factors affect price sensitivity?

Q4. What is the value of a 5-year, AED 1,000 par value bond with an 8% annual coupon if the YTM (required rate of return) of return is 8%? Explain to the manager of the firm without calculation.

Q5. (i). What would be the value of the bond if, just after it had been issued, the expected inflation rate rose by 2%, causing investors to require a 10% return? Would we now have a discount or a premium bond?

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(ii). What would happen to the value of this bond over time if the required rate of return remained at 10% until maturity? Show with a graph and explain to the manager.

Q6. (i). What is an approximation of the yield to maturity for this bond if the bond is selling at AED 900?

(ii). Explain to the management what your fears are, and you believe that the selling price would reach AED 900?

Q7. Calculate the current yield, the capital gains yield, and the duration of the bond (price is found in Q5).

Q8. How would the composition of capital gain yield and current yield fortis bond change over time, as the bond approaches maturity.?

B. Exercises

1). A bond pays a coupon of AED 115 every April 1st for 5 years. Today is October 1, 2019; On September 30rd, 2029 it pays an additional $1,000. YTM is 7.5%. What is the value of the bond?

2). In April 2020 you purchase 100 euros of bonds in Greece which pays a 5% coupon every year. If the bond matures in 2025 (five years) and the YTM is 3.0%, what is the value of the bond?

3). Sheikha just graduated from ZU major in Finance and immediately found a good job in a bank. She plans her retirement. Hence, she contacted an insurance company and she has (a) to choose to invest 1,500 and per quarter at 7.3% compounding for 32 years or invest the corresponding amount of money annually, and (b) to choose when to make payments; at the beginning of the end of the period.

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Questions:(I). In which account will I have more money and by how much?

(II). Which account will earn the most interest and by how much?

4). Suppose you buy a zero-coupon bond at AED 100. The bond matures in 5 tears and its face value is AED 1,000. Calculate the YTM.

5) A company has systematic risk (or beta factor) 1.25, the risk-free rate of interest is currently 5.45%, and the required return on the market portfolio is 12%. The company plans to pay a dividend of AED 3.05 per share in the coming year  and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 2001-2003 period:

End of Year   Dividend
2017                 2.00
2018                 3.00
2019                 2.10

Estimate the stock price value of the company’s share using CAPM.

C.Questions on Efficient Market Hypothesis (EMH)

Question 1. (i). Present the various forms of the efficient market hypothesis.

(ii). What are the implications for these forms for the various types of financial analysts?

Question 2. “According to EMH, no investors are able to outperform the market. However, there are successful analysts and very rich investors (such as George Soros, Warren Buffett, or Peter Lynch) who are able to beat the market. Therefore, EMH must be incorrect”. Comment on the above statement. Is it correct or not and why?

Question 3. “There is a high likelihood that as the ease of trading in a market is increasing, market inefficiency in this market is decreasing. Justify the above statement by comparing the stock market with the real estate market.

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