Question: you are an investment adviser one of your clients approaches...

You are an investment adviser. One of your clients approaches you for your advice on investing in equity shares of Alpha Company.

You have collected the following data:

Earnings per share last year $4.00

Payout ratio 0.40

Return on equity 0.25

Cost of equity capital 0.20

The company plans to increase the payout ratio to 50% after year 5.

Required:

i) Estimate the price of an equity share of this company using an appropriate dividend discount model and advise your client whether they should buy a share of the company.

ii) Your client is keen to know whether there are any positive growth opportunities from their investment. Explain to your client the meaning of this concept using appropriate calculations. Note: Use two decimal places in your calculations 

 

2. You are the portfolio manager of a large company that invests in many securities including corporate bonds. You have been assigned the task of bond portfolio management. You are provided with the following data in relation to bonds:

Maturity period 7 years

Coupon rate 12%

Par value $1,000 Coupons on bonds are paid annually

Yield to maturity of bonds 8%

Required:

i) Calculate the Macualay’s duration, modified duration and convexity

ii) Calculate the change in bond price when yield to maturity changes by one percent using modified duration

iii) Calculate the change in bond price when yield to maturity changes by one percent when convexity is considered