Securities Trading | Debt, Equity and Company Valuation Assignment Answer for Finance Students
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Assignment Details:
- Referencing Styles: Rubric
- Word: 2000
- Subject: Finance
Rubric:
| Exemplary (5 marks) | Competent (3-4 marks) | Needs work (1-2 marks) |
| Analysis is well structured, precise, engaging and has an easy flow and varied sentence structure. Contains no spelling errors, uses correct punctuation and is grammatically correct. | Analysis is reasonably well structured, precise, and engaging. Flow and sentence structure are acceptable. Contains very few spelling errors, uses correct punctuation and is generally grammatically correct. | Analysis lack structure; flow and language are inadequate. Contains numerous spelling errors, non-existent or incorrect use of grammar and punctuation. |
Q1 (Securities trading)
You borrowed $40,000 at an interest rate of semiannual interest rate of 8% per year to buy shares of company X, currently trading at $50 a share. Your account starts at an initial margin of 60%. The stock pays a dividend of $0.50 per share in six months. You pay 0.10% trading cost on each transaction (i.e., buy and sell) of trading the stock. Your broker charges $20 for collecting dividends for you.
(a) You sell the shares after receiving the dividends in six months. If the ex-dividend price is $55 a share in six months, what is the rate of return of your capital investment?
(b) How high or low the ex-dividend share price can go before a margin call is triggered in six months if the maintenance margin is 40%?
Note: In part (b), you are not selling the shares, so no selling transaction cost is involved. Also, use ex-dividend price to define (compute) margin. That is, the “stock value” in the margin definition is the ex-dividend stock value.
Q2 (Debt Valuation)
Bond A is selling at par (i.e., at face value of $1,000) with a coupon rate of 3.5% and 10 years to maturity.
Bond B is selling at $991.73, also with a coupon rate of 3.5% and 10 years to maturity.
Assume that the coupons are paid annually.
Please answer the following questions, with calculation and explanation.
(a) What is Bond A’s yield to maturity?
(b) What is Bond B’s yield to maturity?
(c) Between Bond A and Bond B, which one do you prefer, if both have the same credit risk?
(c) How would your answer to (c) change if you find out that Moody’s credit ratings for Bond A and Bond B are Baa1 and Ba1, respectively?
Q3 (Equity Valuation)
We have seen an example of valuing an advertising company. There, we had the following assumptions:
- Dividend of $2.50 per share for next year.
- Dividend would grow at 2% per annum forever.
- Company’s beta is 1.36.
- Risk-free rate is 1%.
- Market risk premium is 5%.
Using the information above, we are able to price the share at $43.10. Now, please conduct sensitivity analysis, by answering the following questions.
(a) Ceteris paribus (everything else equal), what happens to the share price if we assume a dividend growth of 1.8% or 2.2% per year?
(b) Ceteris paribus, what happens to the share price if we assume the company beta to be 1.224 or 1.496?
(c) Ceteris paribus, what happens to the share price if we assume the market risk premium to be 4.5% or 5.5%?
(d) For each parameter considered in (a), (b), (c), what is the elasticity (sensitivity) between %change in the share price estimate and %change in the parameter assumption?
(e) What is your takeaway on the sensitivity analysis?
Q4 (WACC and Company Valuation)
Please answer the following questions by first stating whether you agree or disagree with the statement. Please explain your choice with no more than 3 sentences.
(a) If a company stock price keeps going up due to good performance, then its beta will increase which would lead to a higher cost of equity.
(b) In a recession, because market premium is low, cost of equity would decrease.
(c) Since the cost of debt is usually lower than the cost of equity, a company may keep issuing more debt to lower its WACC.
(d) Good transparent corporate governance may induce investors to demand less yield on corporate bonds, which in turn may reduce the cost of debt.
(e) Taking on risky pro-cyclical projects will likely increase the company’s CAPM beta and in turn increase the cost of equity.