investment management

Investment Banks and Financial Institutions

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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Investment Management Questions

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Assume that the company is announcing an unexpectedly large dividend to its shareholders. In an efficient market without information leakage, one might expect:
Which one of the following would provide evidence against the semi strong form of the efficient market theory?
According to the efficient market hypothesis:
A “random walk” occurs when:
A market anomaly refers to:

In an efficient market, professional portfolio management can offer all of the following benefits except:
“Highly variable stock prices suggest that the market does not know how to price stocks.” Respond.
Which of the following sources of market inefficiency would be most easily exploited?
Dollar-cost averaging means that you buy equal dollar amounts of a stock every period, for example, $500 per month. The strategy is based on the idea that when the stock price is low, your fixed monthly purchase will buy more shares, and when the price is high, fewer shares. Averaging over time, you will end up buying more shares when the stock is cheaper and fewer when it is relatively expensive. Therefore, by design, you will exhibit good marketing timing. Evaluate this strategy.

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Banking and Financial Institutions

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Banking and Financial Institutions

Question 1

Capital markets refer to the financial markets where debt and equity instruments with maturities of more than one year are traded. Bond markets are part of the capital markets…

Question 2

T-bills are a short term financial instrument used by the government to source for revenue in order to cover for shortfalls. They are sold through an auction, issued in multiples of $1000…

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Question 3

A STRIP (Separate Trading of Registered Interest and Principal Securities) is a form of a treasury financial security whose…

Question 4

Investing in TIPS bonds has the advantage of having their returns based on…

Question 5

Bearer bonds refer to a type of bond where the coupon is attached to the bond and is, therefore, payable to the…

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The Investment Detective Essay

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The Investment Detective

Case Study

Objective of the case:

This case presents the cash flows of eight unidentified investments, all of equal initial investment size. Your task is to rank the projects. The first objective of the case is to examine critically the principal capital-budgeting criteria.

A second objective is to consider the problem that arises when net present value (NPV) and internal rate of return (IRR) disagree as to the ranking of two mutually exclusive projects.

Finally, the case is a vehicle for introducing the problem created by attempting to rank projects of unequal life and the solution to that difficulty—the equivalent-annuity criterion.

The Investment Detective

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Assignments:

Fill the yellow part of the excel sheet. And then answer the following questions:

1) Which of the two projects, 7 or 8, is more attractive?

a. How sensitive is our ranking to the use of high discount rates?

b. Why do NPV and IRR disagree?

2) What rank should we assign to each project?

a. Why do payback and NPV not agree completely?

b. Why do average return on investment and NPV not agree completely?

c. Which criterion is best?

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3) Are those projects comparable based on NPV?

a. Because the projects have different lives, are we really measuring the “net present” value of the short-lived projects?

4) What is the equivalent-annuity method and when is it called for in project comparisons?

The key points ABOUT capital budget should be the following:

IRR: Possibly incorrect opportunity cost assumption. Violates value additivity. Multiple IRRs are possible.
NPV: May be difficult to explain.
ROI: Often computed on profits, not cash flow. Ignores time profile of flows and the time value of money.
Payback: Ignores time value of money, although it is a proxy for the liquidity or duration of an investment and is sometimes used in conjunction with NPV.

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Investment Analysis and Forecasting

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Investment Analysis and Forecasting

Overview

In 3–6 pages, complete a ratio analysis using a provided balance sheet and income statement, specify how you would analyze a potential investment, and describe how you would forecast a company’s potential success.

An investment analysis has two fundamental components: 1) A financial analysis, such as reviewing current financial ratios within the company, and 2) a non-financial analysis, which is reviewing a company’s strategic vision, employee satisfaction, et cetera. The first two parts of your assessment provide an opportunity for you to demonstrate both of these types of analyses.

The goal of forecasting the performance of a company is to estimate the financial performance of a company over a selected period of years. When forecasting a company’s performance, similar to an investment analysis, you look at both financial and non-financial factors. This is the focus of the last part of your assessment.

Investment Analysis and Forecasting

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Library Resources

de Rezende, F. C. (2011). The structure and the evolution of the U.S. financial system, 1945–1986. International Journal of Political Economy, 40(2), 21–44.
Hall, R. E. (2010). Why does the economy fall to pieces after a financial crisis? Journal of Economic Perspectives, 24(4), 3–20.
Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New York, NY: Amacom.
- Chapter 3: Financial Analysis Using Ratios.
Fight, A. (2005). Cash flow forecasting. Jordan Hill, GBR: Butterworth-Heinemann.
- Chapter 4: Cash Flow Forecasting of Financial Statements.
Downes, J., & Goodman, J. E. (2014). Dictionary of finance and investment terms (9th ed.). Hauppague, NY: Barron’s.

Brigham, E. F., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.). Boston, MA: Cengage.

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Expected Interest Rate

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Expected Interest Rate

For this problem, examine Treasury securities. Considering the following numbers, what would the yield on 3-year Treasury securities be?

Real risk-free = 4%.
Inflation expected at 1.5% for this year and 2% for the next 2 years.
Maturity risk premium = 0.

Treasury Securities

Treasury securities—including Treasury bills, notes, and bonds—are debt obligations issued by the U.S. Department of the Treasury. Treasury securities are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government. The income from Treasury securities may be exempt from state and local taxes, but not from federal taxes.

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CAPM and Required Return

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CAPM and Required Return

Calculate the required rate of return for XYZ Inc. using the following information:

The investors expect a 3.0 percent rate of inflation.
The real risk-free rate is 2.0 percent.
The market risk premium is 6.0 percent.
XYZ Inc. has a beta of 1.7.
Over the past 5 years, the realized rate of return has averaged 13.0 percent.

A principal advantage of CAPM is the objective nature of the estimated costs of equity that the model can yield. CAPM cannot be used in isolation because it necessarily simplifies the world of financial markets. But financial managers can use it to supplement other techniques and their own judgment in their attempts to develop realistic and useful cost of equity calculations.

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Bond Valuation

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Bond Valuation

You have two bonds in your portfolio. Each bond has a face value of $1000 and pays an 8 percent annual coupon. Bond X matures in 1 year, and Bond Y matures in 15 years.

If the going interest rate is 4 percent, 9 percent, and 14 percent, what will the value of each bond be? Assume Bond X only has one more interest payment to be made at maturity. Assume there are 15 more payments to be made on Bond Y.
The longer-term bond’s price varies more than the shorter-term bond‘s price when interest rates change. Explain why.

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Yield to Maturity Assignment

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Yield to Maturity

XYZ Inc. bonds have 5 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 8 percent.

What is the yield to maturity at a current market price of (1) $800 and (2) $1,200?
If a “fair” market interest rate for such bonds was 12 percent—that is, is rd=12%—would you pay $800 for each bond? Why or why not?

YTM – otherwise referred to as redemption or book yield – is the speculative rate of return or interest rate of a fixed-rate security, such as a bond. The YTM is based on the belief or understanding that an investor purchases the security at the current market price and holds it until the security has matured (reached its full value), and that all interest and coupon payments are made in a timely fashion.

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