| Country : | Australia |
|---|
Assignment Task:
Task:
Question 1 20 marks
Table A represents a multifactor (APT) model of a given stock’s security returns.
Factor Factor Beta Factor Risk Premium Inflation 1.4 5%
Industrial production 0.6 7
Oil prices 0.4 2
Table A
a. If the risk-free rate of interest is currently 5% and the stock is regarded by the market as fairly priced, what is the expected rate of return on the stock? (10 marks)
The expected market value and the subsequent actual market value for each of the three macro factors is given in Table B.
Table B
Factor Expected Value Actual Value
Inflation 5% 4%
Industrial production 3 5
Oil prices 3 2
a. Calculate the revised expectations for the rate of return on the stock once the actual market values become known. (10 marks)
Question 2 30 marks
The market rate of return over the next 12 months is expected to be 10% and the risk free rate of return is 4%. Gold Co. stock has
a beta of 0.4 and the value of its outstanding equity is AUD 110 million.
a. What is your estimate of the rate of return on Gold Co.’s stock given that you have no reason to believe that the stock is not fairly priced? (10 marks)
b. If it transpires that the actual market return is 8%, how would this impact your estimate? (10 marks)
c. During the year Gold Co. wins an insurance claim related to a mining accident and is awarded a settlement of AUD 4 million. Gold Co.’s stock return during the year is 8%. If there were no other firm specific events impacting on Gold Co. during the year, what do you think the market expected the insurance settlement to be? (10 marks)
Question 3 50 marks
A 25 year maturity bond with a face value of $1,000 and making annual coupon payments with a coupon rate of 10% has duration of 12 years and convexity of 184.7. The bond currently sells at yield to maturity of 7.5%.
7.5%
Yield to Maturity
6.0%
Yield to Maturity
8%
Yield to Maturity
Settlement Maturity Rate
Yld
Redemption Frequency PRICE ($)
a. Complete the table above to provide the appropriate Excel spreadsheet entries to calculate the price of the bond at the current yield to maturity, at yield to maturity of 6% and at yield to maturity of 8%.
b. What price would be predicted by the duration rule (using modified duration) if the bond's yield to maturity falls to 6%? (Show your workings). (10 marks)
c. What price would be predicted by the duration-with-convexity rule if the bond's yield to maturity falls to 6%. (Show your workings). (10 marks)
d. What is the percent error for each rule? (5 marks)
e. Are the findings consistent with the observation that the duration rule always underestimates the new value of a bond following a change in its yield and predicts a lower, and less accurate, bond price than the duration-with-convexity rule? (5 marks)
f. Is any difference in the accuracy of the two rules of practical importance? (10 marks)
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