Assessment 1 attempt 2 - Perdisco week 1 PDF

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Perdisco week 1...

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17/05/2020

Assessment

Course assessment This attempt will impact your course performance

Assessment [feedback page] This is a feedback page. You have NOT yet finished your assignment. Please read the following paragraph carefully. When you are ready, you must complete this assignment by clicking finish. You will then see your final score. Once you have clicked finish you will not be able to return to this feedback page, so please ensure that you print or save it to your computer if you want to refer to it later. If you do not click finish your score will not be displayed on your e-workbook home page. However, your results will be provided to your instructor.

1 of 8

ID: FS.EM.D.01A

[2 marks]

Determine whether the following statements regarding the pricing of securities are true or false:

True a)

Share prices can be calculated with certainty using a special formula.

b)

Debt securities such as bills and bonds can be calculated with certainty using a certain formula

Feedback

False

[2 out of 2]

a) You are correct. b) You are correct.

Discussion Unlike bills and bonds, share prices cannot be exactly calculated using a formula. This is because the future dividends that shares will pay are not fixed and investors will regularly change their expectations of what those payments will be. Share prices will consequently also be very volatile and will be influenced by investor sentiment. There is a formula that will estimate share prices at a particular point in time, but the price it produces is not fixed or certain. The formula is:

P=

D k-g

Debt securities on the other hand have fixed coupon payments and discount rates. Consequently their prices can be calculated with certainty.

2 of 8

ID: FS.EM.D.03A

[1 mark]

Match each description to a type of market sentiment in the drop down lists. a) Investors are optimistic and share prices are rising.

bull market

b) Investors are pessimistic and share prices are falling.

bear market

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Feedback

[1 out of 1]

You are correct.

Discussion One common method used to remember which market is which is:

A bull will toss you up into the air with its horns. Hence a bull market is a rising market. A bear will drop you down with its claws. Hence a bear market is a falling market.

3 of 8

ID: FMTH.BI.SI.01A.L

[1 mark]

Calculate the price (P) of the following Promissory Note assuming that the yield is a simple interest rate:

MATURITY VALUE: $89,000 PURCHASE PRICE: $______ TERM TO MATURITY: 110 days YIELD TO MATURITY: 5.19% per annum

Give your answer in dollars and cents to the nearest cent. P = $ 87610.64

Feedback

[1 out of 1]

Your answer is within an acceptable range of the correct answer and you have received full marks.

Calculation The price of a Promissory Note is equal to the present value of its future payment at the interest rate required by the purchaser. This can be calculated using the following formula: show variables

S = P(1 + r.t) P = =

Rearrange to make P the subject

S (1 + r.t) 89,000 (1 + 0.0519 × 0.30136986...)

= 87,629.38045745... = $87,629.38

Rounded as last step

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Assessment

4 of 8

ID: FS.CF.D.SM.02A

[2 marks]

Determine whether the following statements regarding the ASX are true or false:

True a)

The Australian Stock Exchange (ASX) allows selected investors to perform their own trading activities.

b)

The ASX is one of the few markets internationally that allows retail-sized transactions.

Feedback

False

[2 out of 2]

a) You are correct. b) You are correct.

Discussion All market trading activities must be undertaken by professional dealers and brokers. The investors themselves (no matter how big or small they are) cannot undertake trading activities in organised secondary markets (such as the ASX) on their own behalf. Instead, they must pay a broker to do so. The ASX is one of the few markets that will allow retail sized transactions to be undertaken, but such transactions must still be executed by a broker, and not performed by the retail investor him/herself.

5 of 8

ID: FMTH.BO.O.03A.L

[1 mark]

An investor holds a portfolio of short-term money market instruments and bonds. Select the trading strategy that will maximise the investor's return:

Disregard the market interest rate when trading Buy when interest rates are low, sell when interest rates are high Buy and sell at the same interest rate Buy when interest rates are high, sell when interest rates are low

Feedback

[1 out of 1]

You are correct.

Discussion Prevailing market interest rates and prices of short-term money market instruments and bonds are inversely related. For instance, if the risk-free cash rate is 5%, the market would require prices of risk-free bills and bonds to reflect that cash rate and earn a yield more or less equal to 5%. Therefore, if this rate were to increase, the yield of corresponding bonds and bills on the market will also need to increase, and this will (all other things being equal) lead to an decrease in the prices of these bonds and bills. In order to maximise return an investor should purchase short-term money market instruments and bonds at a price which they believe to be low and sell them when these same instruments are valued at a higher price ('buy low, sell high'). Therefore, they should buy when interest rates are high (lower price) and sell when interest rates are low (higher price). Commentary

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Assessment

It is important to note that interest rate movements in the market do not affect the yield to maturity for existing bonds per se. A bond that earns a yield of 6% for example, still earns 6% even if the market rate increases; the price that was paid for the bond, the coupon rate and the redemption value do not change. However, if this bond were to be put on the market after the rate change, a new price will be calculated for the bond under current market rates. If the bond were to be sold at this new price, then this new yield to maturity calculated from this price would be more or less reflective of new market rates. Another important note is that there should be a distinction drawn between the market price of the bond and the book price. The market price of a bond is the price that the market would pay for the same set of coupons and redemption value at the current prevailing market rates. Changes in the interest rate would affect the market price of a bond. On the other hand, the book price of a bond is calculated using the original yield to maturity and is not affected by changes in market interest rates after the bond is sold. The book price (and the yield to maturity) only changes when the bond is sold again.

6 of 8

ID: FMTH.B.PON.01A.L

[1 mark]

Gurgle wishes to fund their ever-growing company by issuing bonds with a face value of $100 and an effective semi-annual coupon rate of 2% which are to be redeemed at par in 3 years. The company claims that the prices on these bonds are calculated at a yield of 6% pa compounded semi-annually. Calculate the price of each bond (P). Give your answer in dollars and cents to the nearest cent. P = $ 94.58

Feedback

[1 out of 1]

You are correct.

Calculation Since the bond is to be redeemed at par, the redemption value that is to be paid upon maturity is equal to the face value (that is show variables

P

= K +

r (F- K ) i

= 100(1 + 0.03)-6 +

0.02 ( 100 - 100(1 + 0.03)-6 ) 0.03

= 83.74842567... + 10.83438289... = 94.58280856... = $94.58

Rounded as last step

Alternatively, the price can be calculated by: show variables

P

= M(1 + i)-n + C [ 1 - (1 + i) i

-n

]

= 100(1 + 0.03)-6 + 2 [ 1 - (1 + 0.03) 0.03

-6

]

= 83.74842567... + 10.83438289... = 94.58280856... = $94.58

7 of 8

ID: FMW1.06.119

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Rounded as last step

[3 marks] 4/7

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Assessment

You are about to price a bond. For each of the scenarios below, select the correct pricing result from the drop down list. a) The coupon rate is 5.0% and the market yield is 6.2% The bond will be at a discount. b) The coupon rate is 12.5% and the market rate is 12.5% The bond will be at par. c) The coupon rate is 7.5% and the market yield is 5.7% The bond will be at a premium.

Feedback

[3 out of 3]

a) You are correct. b) You are correct. c) You are correct.

Discussion Bond is at par

A bond is at par when its price is equal to its face value. This happens when the coupon rate is equal to the market yield. The investor will invest an amount equal to the face value, will receive the coupons equal to the market yield, and will receive their money back at the end of the term. Bond is at a discount

A bond is at a discount when its price is below its face value. This happens when the coupon rate is below the market yield. The coupon rate is fixed so the investor will not receive a sufficient return through the coupons alone. As a result, they need to obtain an additional source of profit. They do this by creating a capital gain by paying less for the bond than its maturity (face) value. Bond is at a premium

A bond is at a premium when its price is above its face value. This happens when the coupon rate is above the market yield. The coupon rate is fixed so the investor will receive too much return through the coupons. As a result, they need to make a loss somewhere in the transaction. They do this by creating a capital loss by paying more for the bond than its maturity (face) value.

8 of 8

ID: FMTH.BO.Y.01.L

[1 mark]

The Royal Bank of South Nakaratu is planning to issue the following bonds:

REGISTERED BOND PURCHASE PRICE: $988 TERM: 6 years FACE VALUE: $1,000 COUPON RATE: 7.50% payable half-yearly https://www.perdisco.com/elms/qsam/html/qsam.aspx

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Assessment

The holder of this bond is entitled to half-yearly coupon payments plus a repayment of the face value at the maturity date.

Calculate the yield to maturity of this bond as a nominal rate per annum compounded half-yearly. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result. Yield =

7.754 % pa

[1 out of 1]

Feedback

You are correct.

Calculation To find the yield per half-year, you must first set out an equation in which the yield per half-year, i, is the unknown to be solved as follows: show variables

P = C [ 1 - (1 + i)

-n

i

] + F(1 + i)-n

988 = 37.5 [ 1 - (1 + i)

-12

i

] + 1,000(1 + i)-12

... call this equation A

However, this is not an easy equation to solve for i. Indeed, if you attempt to find the answer by trying to make i the subject of this equation you may find that the algebra gets too difficult! Luckily, there are three ways to solve this equation for i. The method you choose will depend on how you are being taught to solve these types of questions. You can disregard the methods that are not familiar to you (or try them all to learn alternative approaches). The methods are presented here in increasing order of accuracy. To view each step-by-step approach, click the respective headings. Approach 1. Estimating Approach 2. Linear interpolation Approach 3. Using a financial calculator Irrespective of the approach used to estimate i, it must be noted that i is a half-yearly rate. To convert this rate to a percentage per annum, you must multiply i by 2. For each approach outlined above this means that:

Approach 1 Yield

= 3.75% × 2 = 7.5% pa compounded half-yearly

Approach 2 Yield

= 3.880% × 2 = 7.76% pa compounded half-yearly

Approach 3 Yield

= 3.87695139...% × 2 = 7.754...% pa compounded half-yearly (this is the exact answer to 3 decimal places)

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Assessment

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