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Investment Banks & Financial Institutions

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Investment Banks and Financial Institutions

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Investment Banks and Financial Institutions

1. Answer questions 4-8 in the attached document.
2. Answer Problems 35, 37, 39, and 41 in the attached documents then answer them again using the below scenarios.
3. Redo problem 35, assuming a coupon rate of 8% in part a, and yields to maturity of 12 and 12.5% in part b ?
4. Repeat problem 37, assuming that the zero coupon bond has 7 years to maturity.
5. Repeat problem 39, assuming that the three bonds under consideration have 6 years to maturity.
6. Repeat problem 41, assuming that the fair present value rose from $975 to $ 990.

Investment banking is the division of a bank or financial institution that serves governments, corporations, and institutions by providing underwriting (capital raising) and mergers and acquisitions (M&A) advisory services. Investment banks act as intermediaries between investors (who have money to invest) and corporations (who require capital to grow and run their businesses).

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Investment Banks and Financial Institutions

PART 1
Questions 4 to 8
Question 4
Identify whether a bond will be considered a premium bond, a discount or a par bond
a) A bond with a market price higher than its par value is a premium bond
b) A bond with a coupon rate equals to its yield to maturity is considered a par bond
c) A bond with a coupon rate less than the required rate of return is considered a discount bond
d) A bond whose coupon rate is less than its yield to maturity is considered a discount bond
e) A bond whose coupon rate is greater than its yield to maturity is considered a premium bond
f) a bond whose fair value is less than its face value is considered a discount bond

Question 5
How equity valuation differ from bond valuation
Valuation of equity onsiders dividend on stock, growth rate, rate of return. These considerations are appropriate where an entity uses dividend growth model
formular where dividend growth factor is equal throughout: Po = D1/r – g
where dividend growth factor is not equal: Po = {Dn (1 + gn)/r – g} (1/(1 + r)n)
Valuation of bond considers bond coupon rate, investors required rate of return, maturity value and maturity period
Formulae = (Intr x PVAF) + (MV x PVIFrn)

Question 6
What happens to the fair present value of a bond when the required rate of return on the bond increases
An increase in required rate of return lowers the fair present value of a bond

Question 7
A change in interest rate affects the price of of both short and long because change in interest rate affects the yield of both and long and short-term loan
Long-term bond’s price is more affected by increase in interest rate due to long duration they cove

Question 8
Bond’s price with large coupon rate are affected with the change in interest rates more than bond’s price with a small interest rate.
This is because large coupon rate reduces bond’s price by a larger margin.

Investment Banks and Financial Institutions

PART 2
Aswer problems
Problem 35
a) what is the duration of a five year treasury bond with a 10% semi-annual selling at per
periods = 2 x 5 years = 10 periods
par value= $1000
coupon = 10%/2 = 5%
interest = 5% x 1000 = 50
bond = (50 x PVIF 10 periods @ 5%) + (1050 x PVIF10 periods @5%) =
= 47.62 + 952.38 X10 = $9571.42
Price = 952.38 + 47.62 = $1000
period = 9571.42/1000 = 9.57/2 = 4.78

b) duration if the yield to maturity increases to 14% and 16%
1st period interest 14% x 1000 x 1/1+0.14 = 122.81
2nd (140 + 1000 ) x 0.7695 = 877.19
(877.19 x 10 ) + 122.81 = $8894.71
price = 1000
8894.71/1000 = 8.89/2 = 4.4 YEARS

At 16%
1st period interest 16% x 1000 x 1/1+0.16 = 137.93
2nd (160 + 1000 ) x 0.7432 = 862.07
(862.07 x 10 ) + 137.93 = $8758
price = 1000
8758.62/1000 = 8.75/2 = 4.3 years

c) Conclusion
An increase in bond yield to maturity reduces the duration of a bond. This is because an increased yield to maturity increases the cash inflow hence reducing the period of maturity

Problem 37
Duration of zero coupon bond that has eight years to maturity
The duration of a bond with a zero coupon rate is the same its maturity date. Thus the duration of the bond is 8 years
if the duration of maturity increases to 10 years, bo nd duration will be 10 years
if the maturity increases to 12 years, bond duration will be 12 years

Problem 39

a) At 8%
interest = 8% x 10000 = 800
1st 800 x 0.9259 = $740.74
2nd (800 + 10000) x 0.8573 = 9259.26
total = (9259.26 x 5) + 740.74 = $47036.29/10000 = 4.7 years

b) at 10%
interest = 10% x 10000 = 1000
1st 1000 x 0.9091 = $909.10
2nd (1000 + 10000) x 0.8264 = 9090.91
Total = (9090.91 x 5) + 909.1 = $46363.65/10000 = 4.6 years

c) coupon rate 12%
interest = 12% x 10000 = 1200
1st 1200 x 0.8929 = $1071
2nd (1071 + 10000) x 0.7972 = 8825.73
Total = (8825.73 x 5) + 1071= $45199.67/10000 = 4.5 years

Problem 41
At 9.75%
interest = 9.75% x 975 = $95.06

at 9.25%
interest = 9.25% x 995 = $92.04
995/92.04 = 974/95.06 = 10 years

Investment Banks and Financial Institutions

PART 3
Problem 35
a) Coupon rate of 8%
interest = 8% x 1000 = 80
1st 80 x 0.9259 = $74.07
2nd (80 + 1000) x 0.8573 = 925.92
total = (925.92 x 5) + 74.07 = $4703.63/10000 = 4.7 years

b) yield to maturity is 12%
interest = 12% x 1000 = 120
1st 120 x 0.8929 = $107.1
2nd (107.1 + 1000) x 0.7972 = 882.57
Total = (882.57 x 5) + 107.1= $4519.96/1000 = 4.5 years

Yield to maturity is 12.5%
interest = 12.5% x 1000 = 125
1st 125 x 0.8889 = $111.1
2nd (111.1 + 1000) x 0.7901 = 877.91
Total = ( 877.91 x 5) + 111.1= $4500.63/1000 = 4.5 years

Investment Banks and Financial Institutions

PART 4
Problem 37
Duration of zero coupon bond that has seven years to maturity
The duration of a bond with a zero coupon rate is the same its maturity date. Thus the duration of the bond is 7 years
if the duration of maturity increases to 10 years, bo nd duration will be 10 years
if the maturity increases to 12 years, bond duration will be 12 years

PART 5
Repeat problem 39,assuming that the three bonds under consideration have 6 years to maturity.

a) At 8%
interest = 8% x 10000 = 800
1st 800 x 0.9259 = $740.74
2nd (800 + 10000) x 0.8573 = 9259.26
total = (9259.26 x 6) + 740.74 = $56296.3/10000 = 5.6 years

b) at 10%
interest = 10% x 10000 = 1000
1st 1000 x 0.9091 = $909.10
2nd (1000 + 10000) x 0.8264 = 9090.91
Total = (9090.91 x 6) + 909.1 = $55455.37/10000 = 5.5 years

c) coupon rate 12%
interest = 12% x 10000 = 1200
1st 1200 x 0.8929 = $1071
2nd (1071 + 10000) x 0.7972 = 8825.73
Total = (8825.73 x 6) + 1071= $54025.38/10000 =5.4 years

Investment Banks and Financial Institutions

PART 6
Repeat problem 41, assuming that the fair present value rose from $975 to $ 990

duration = 990/9.25 = 10.7 years

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Banking and Financial Institutions Case Study

Hansson Private Label

There is a proposal for a $ 50 million expansion for Hanson Private Label or HPL. HPL manufactured personal care products such as sop, shampoo and mouthwash The proposed expansion is HPL’s response to a retail customer’s desire to expand HPL’s share of their private label manufacturing. Consider the firm’s overall competitive strategy and proceed as follows:

How would you describe HPL and its position within the private label personal care industry ? Use Exhibit 1 to obtain the firm’s profitability, growth rate and leverage (see Exibit 8 as well) versus its competitors.
Estimate the project’s NPV. Would you recommend that Tucker Hanson proceed with the investment ?

Banking and Financial Institutions Case Study

NPV Analysis with Constant Growth

Operating Results

2009 2010 ……..2018

Revenue (Use Exhibit 5)

Less: Raw Material Costs Unit Volume x Raw Materials per unit Exhibit 5

Less Labor Expense Total Labor Cost Exhibit 5

Less: Manufacturing Overhead Exhibit 5

Less: Maintenance Expense Exhibit 5

Less: Selling, General and Administrative Expense .078 x Revenue see Exhibit 5

EBITDA = Earnings before interest, taxes, depreciation and amortization Revenue – Raw Material Costs – Labor Expense – Manufacturing Overhead –Maintenance Expense – Selling, General and Administrative Expense

Banking and Financial Institutions Case Study

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The next line is depreciation. The figure of 4000 is given on p.5 in the table.

Use this figure for each year.

Less: Depreciation expense

EBIT = EBITDA – Depreciation

Less Taxes

Taxes = EBIT x .4

NOPAT

Unlevered Free Cash Flow:

NOPAT

Plus Depreciation

Less: Change in Working Capital

Banking and Financial Institutions Case Study

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For Working Capital, perform this computation

Accounts Receivable/sales/360 = Days Sales Outstanding

Accounts Receivable = Days Sales Outstanding from Exhibit 5 x Revenue from the top line of this chart/360

Accounts Payable= Days Sales Inventory x inventory/360

Days Sales inventory is from Exhibit 5 and inventory is the 2007 figure on page 6.

The next line is unlevered free cash flow. Compute for each year.

Cost of capital: Take any WACC from Exhibit 7’s last column in the second short table such as 9.38%.

Return of Working Capital

Use 3, 147 prior to 2009 and 7,174 in 2018.

From page 3, add facilities expansion, manufacturing equipment and packaging equipment to get the initial investment.

Compute NPV = – Initial investment + PV of an annuity of annual unlevered free cash flows

For payment, use the unlevered free cash flows obtained in this analysis. For i/y, use the cost of capital. For n, count the number of years from 2018 to 2009.

Banking and Financial Institutions Case Study

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