Investment And Financial Analysis

Yield to Maturity (YTM)

1. a) Yield to maturity is the rate that is used to discount the future cash flows associated with the bond. Typically it is the return earned by the bondholder for purchasing and holding the bonds till their maturity. This rate equates the present value of the cash flows related to bond with their current market price. YTM is also referred as internal rate of return or the market interest rate (Stack Exchange, 2018).

Part b

Formula	$1,276.76 = $80 ×Annuity factor(r, 30) + $1,000 ×PV factor(r, 30)
FV Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	1000
Price	1276.76
Maturity	30
Coupon	8%
PMT	$80.00
Bond Equivalent Yield	6% (rounded off)

c. The critical assumptions embedded in the 30-Year Bond yield to maturity figure are as follows:

• The holder of the bond will keep the bond till the maturity of such bonds.
• The coupon (interest on bonds) must be invested at the same rate as that of YTM (Stack Exchange, 2018).

2. a)

Years	Cash Flows ($)	DCF	PV ($)
1	60	0.917	55.046
2	60	0.982	58.934
2	1000	0.982	982.240
	Price of bond		1096.220

b)

Bond Price=

( (Coupon/YTM)* ( 1-(1/(1+YTM/2)2M) ) + (FV/(1+YTM/2)^2M)

c) Yield at year 2 is lesser than yield to maturity at year 2 because the yield to maturity includes the year 1 interest payment made on the bond. However, year 2 yield only covers only interest and principle payment.

3. a) Bond Laddering is a strategy which involves maturity weighting under which funds of the investors are divided among different bonds that have longer maturities. This strategy is used to reduce or minimise the risk of interest rate fluctuation and re-investment risk (Investinginbonds.com., 2018).

For example:

John has invested funds in equal amounts to different bonds which will mature at the regular intervals.

Bond A	Bond B	Bond C	Bond D	Bond E
Maturity: 2 Years	Maturity: 4 Year	Maturity: 6 Year	Maturity: 8 Year	Maturity: 10 Year
Amount= $20000	Amount= $20000	Amount= $20000	Amount= $20000	Amount= $20000
Interest Rate= 1.55%	Interest Rate= 2.05%	Interest Rate= 2.80%	Interest Rate= 3.22%	Interest Rate= 3.30%

The average maturity of the portfolio consisting of above bonds is 15 years. Now, when the bond A will mature after 2 years, John will have two options:

Either to reinvest his principle in a fresh 10 year bond or to take the money out and invest somewhere else.  The other bonds will be 2 years closer to their respective maturity now.

Bond laddering strategy is a buy-hold strategy that can be used as support for the potential impact of rising interest rates (Carlson, 2018).

b) Dollar cost averaging involves purchasing of more shares when the market is down and less shares when the market is up. While bond ladder involves investment in multiple securities at a single time, in almost equal amount (Leach, 2018). Bond ladder is for high interest yielding securities.

4. a) Open-Ended Mutual Fund v/s Exchange Traded Fund (ETF)

• The prime similarity among Open ended Mutual Funds and Exchange Traded Fund is that they both portray professionally managed baskets or the collections of various bonds or securities.
• Further, both of these funds provide a wide variety for the investment options.

Basis	Exchange traded funds	Open Ended Mutual Funds
Expense Ratio	The expense ratio of ETFs lies in between the range of 0.1% to 1.25%	The expense ratio of Open ended mutual funds  lies in between the range of 0.1% to 10%
Pricing	These funds are priced throughout the day at the market price on the trading day which may not be similar to the Net asset value.	These are priced once per day and that too at the end of the trading day. These are priced at NAV
Tax efficiency	Low Cost, Tax efficient and involves transparency.	These are less tax efficient (Anspach, 2018).

b. Open-Ended Mutual Fund vs. Hedge Fund

• Both the funds work as an investment pool and involve investment in various securities such as stocks bonds and commodities.
• Further, both the funds are managed by the professional experts.

Basis	Hedge funds	Open Ended Mutual Funds
Investors	In hedge funds, funds of limited investors are permitted to be pooled for the purchase of assets.	In Mutual funds, the funds of number of investors are managed by the fund manager to purchase bunch of securities from the market.
Aim	These funds aim at offering maximum possible returns to the investors.	These funds aim at provision of return in excess of risk free return rate that is offered in market.
Investors	Established individuals with high risk bearing capacity.	Retail investors who invests their limited income to multiply their money.

5. An investment plan must be diversified so as to manage the risk of overall investment. Diversification involves making investment in different types of investment vehicles in the amounts that must be decided according to the risk and reward generating capacity of each investment vehicle. Stocks give the investors income in two forms: dividend and capital gain. When the investors are not looking for a source of steady income they can opt for equity investment which will not only provide them return in the form of dividend but also it will provide them the stake in the company’s holding in the form of voting rights (Finra, 2018). However, when the investors expect steady returns they must invest in bonds as they generally provide fixed income. Mutual funds are again a better option for the potential investors as these funds allow them to put their savings in the pool of investments on the basis of benefits and limitations of each security. Since in the current case, Anna will require a loan to be repaid and for this purpose it will require funds it must invest prudently.

For example Anna has 100 lacks dollars to be invested. Then it must invest 40% in equity, 30% in debt or bond and in mutual funds. This will allow her to diversify the investment.

6.

Current Free Cash Flow to the Firm (FCFF)	745
Outstanding shares	309.39
Equity beta	0.9
risk-free rate	5.04%
Equity risk premium	5.50%
Cost of debt =	7.10%
Marginal tax rate	34%
Capital structure:
Debt	20%
Equity	80%
Long-term debt=
Growth rate of FCFF
1-4th Years	8.80%
Year 5	7.40%
Year 6	6.00%
Year 7	4.60%
Year 8	3.20%
Ke	RF + Beta (Risk Premium)
	9.99%
Kd	Before tax Kd (1-tax rate)
	4.69%
WACC	Proportions	Rates	Weighted Rates
Debt	20%	4.69%	0.94%
Equity	80%	9.99%	7.99%
WACC			8.93%
Value of firm
1	810.56	0.918	744.12
2	881.88928	0.843	743.23
3	959.4955366	0.774	742.35
4	1043.931144	0.710	741.47
5	1121.182049	0.652	731.06
6	1188.452971	0.599	711.40
7	1243.121808	0.550	683.13
8	1282.901706	0.504	647.20
	PV of Cash Flows		5743.97
	Continuing Value		1282.90
			5.73%
	CV		22392.33586
	PV of CV		11296.52549
Part c	Value of firm		17040.50
Part d	Value of Equity
	Value of firm		17040.50
	Less: Value of Debt		1518
	Value of Equity		15522.50

Value per share
Value of Equity/ Number of shares	15522.50/309.39
Value per share	$ 50.17

7. a) An investor pays attention to interest rates and yield spreads because:

The yield of any bond is mainly comprised of two things: Interest rate and the Credit spread. Interest rate serves as the base rate for each type of bond which is denominated in a particular currency and it compensates for the baseline economic risks of the investors (Finra, 2018). The credit spread or yield spread reflects the difference between rates quoted for two investments with different qualities and maturities. This spread represents idiosyncratic risks which is associated with the specific issuer of the bond or security (Fidelity, 2018).

b) The key factors that cause interest rates to move:

• Supply or demand: The demand and supply of money in an economy leads to change in movement in interest rates. Increase in demand or decrease in supply of money leads to the interest rates of an economy go up and vice versa.
• Inflation: When the rates of goods and services in an economy rise, the interest rates also increases and vice versa.
• International borrowings: With the increased scope of globalisation it has become quite common that the companies can borrow required funds from the foreign markets and when foreign investors competes the local finance providing institutions, the interest rates moves.
• Federal fund rates:  These are the rates that are being charged by one bank from another for their short term borrowing and lending transactions. When federal banks charges higher rates, the interest rates for the normal citizens of the country increase.

8. a) Riding the yield curve means purchasing the long term bonds or securities and selling them before their maturity. The basic purpose behind their execution is to reap certain interest rate benefits from the market. Suppose we are riding a yield curve and the yields rises considerably we will have to bear a capital loss on such a riding position. If such instrument was purchased which matched our investment horizon, it would certainly result in positive return (Bieri & Chincarini, 2005).

b)

Year	CFS	PVF	PV of CFS
1	60	0.934579	56.07477
2	60	0.889996	53.39979
3	60	0.816298	48.97787
3	1000	0.816298	816.2979
			974.7503

9. a) Portfolio A offers most of the income to the investors in the form of dividend and it seems to be held by the retired couple as they would be looking for an investment that is less risky in terms of return fluctuations and they could have a steady source of income. The portfolio that provides dividend as the income generally involves less risk because of constant income. On the other hand, portfolio B provides returns to the investors in the form of capital gains. This is likely to be held by someone who is not in the need of current income and is willing to bear high risk as the prices of the shares keeps on fluctuating and there is a risk of fluctuation of such price on a negative side and also there are possibilities of price increment where one can make higher returns.

b)

Face Value	100000
Bond Interest Rate	12%
Income	12000
Tax Rate	25%
Tax	3000
Net Tax Income	9000
Annual HPR	9.00%

c)

Beta	1.3
Market Return	10%
Risk Free Rate	2%
Portfolio Return	12%
Treynor’s Measure	Portfolio Return – Risk Free Rate
for portfolio	Portfolio beta
	7.69%
Treynor’s Measure	Market Return – Risk Free Rate
for portfolio	Portfolio beta
	6.15%

References:

Stack Exchange. 2018. Yield-to-Maturity and its assumption. Retrieved from: https://quant.stackexchange.com/questions/33028/yield-to-maturity-and-its-assumption 

Investinginbonds.com. 2018. Bond Investment Strategies.  Retrieved from: https://investinginbonds.com/learnmore.asp?catid=6&id=386 

Finra, 2018. Smart Bond Investing.  Retrieved from: https://www.azinvestor.gov/Documents/Smart_Bond_Investing-FINRA.pdf 

Leach, 2018. Are There Better Strategies Than Dollar Cost Averaging? Retrieved from: https://www.suredividend.com/better-than-dollar-cost-averaging/ 

Carlson, B., 2018. The Lump Sum vs. Dollar Cost Averaging Decision. Retrieved from: https://awealthofcommonsense.com/2018/05/the-lump-sum-vs-dollar-cost-averaging-decision/ 

Anspach, D. 2018. The Difference Between ETFs and Open-Ended Mutual Funds. Retrieved from: https://www.thebalance.com/differences-between-etf-s-and-open-ended-mutual-funds-2388639 

Fidelity. 2018. How interest rates affect bonds. Retrieved from: https://www.fidelity.com.sg/beginners/bond-investing-made-simple/how-interest-rates-affect-bonds 

Bieri, D. S., & Chincarini, L. B. (2005). Riding the yield curve: a variety of strategies. Journal of Fixed Income, 15(2), 6.