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ACC00716 Finance

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  • Course Code: ACC00716
  • University: Southern Cross University
  • Country: Australia

Question:

You have been assigned an ASX listed company as the context for this assignment.

1. TVM and bond valuation questions

  1. Your case company has debt maturing in three years (amount shown in Table 1 on page 4 of this document). How much should the company invest now in an account paying 5% APR, compounded monthly, to ensure it has sufficient funds to repay the debt when it matures?

  2. Your company has annual operating revenue as shown in Table 1. Assume this revenue will grow continuously at the annual rate shown in Table 1. What is your prediction for annual operating revenue in 10 years?

  3. Your company has several long-term cash investment options available to it, Investments A, B and C. The interest rates (APR) for these options are given in Table 1. What is the EAR of the investment option the company should choose?

  4. Your company is buying new equipment for the amount given in Table 1. To finance this, the company’s bank has offered an amortised loan at 4.5% APR, monthly compounding, with 20 years of monthly payments. What monthly payment will the company have to make on this loan? Assume that the entire equipment cost is financed and that payments are made at the end of each period.

  5. Your company has an issue of $1,000 par value annual coupon bonds with 10 years remaining until maturity. The annual coupon rate is given in Table 1, along with the current price of the bonds. What is the yield to maturity on the bonds?

  6. Your company has an issue of $1,000 par value bonds with an 8% coupon rate and quarterly coupons. The bonds have 7 years remaining until maturity. The current required return on these bonds is given in Table 1. What is the current price of the bonds?

2. Risk and return analysis

  1. Drawing on expectations from theory and incorporating the overall context of your chosen company.
 

Answer:

1:

Requirement a:

 

Requirement b:

 

Requirement c:

 

Requirement d:

 

Requirement e:

 

Requirement f:

 

2:

The application of modern portfolio theory helps in explaining the concept of measures of interpretation of return and risks of investment. When it comes to perform the analysis of finance and investment by individual investors and company as a whole, one of the most influential theories is modern portfolio theory. The mathematical formulation of diversification of risks in investing is explained in the modern portfolio theory. Objective of portfolio theory is to select a portfolio with the maximum possible expected return with minimum level of risks (Berk and Van 2016). Or it can also happen that investor’s tries to minimize the risks associated with investment at its lowest level for certain level of expected return. Therefore, the theory is viewed as the form of diversifying the risks associated with the financial assets by finding the best diversification strategy using the theoretical concepts. Since the model is based on standard deviation and expected returns of several portfolios of assets, the analysis of several portfolio of given assets helps in making the most efficient selection. In the event of investors have chosen assets that are not moving together, theory assist them in reducing the level of risks (DeFusco et al. 2015).

 


Several fundamentals and assumptions form the basis on which the modern portfolio theories have been constructed. No transaction costs are involved in selling and buying of assets and the determination factors for buying securities is risk. There is infinite market liquidity and investors can make investment of any size in the securities. Tax is not considered by investors while making investment decisions and any form of capital gains and dividends does not make investors differential towards investment. On risk measurement, identical views are shared by investors. Buyers will be interested in buying the securities because it will have a level of risks that will be corresponding to returns sought by him. On the other hand, sellers will be interested in selling their security because there would be another security having volatility level corresponds to desired returns. In order to choose the best portfolio from among the given set of portfolios, it is necessary to make two essential decisions each having respective opportunities of return and risks. The first decision would be to determine an efficient set of portfolio and the second decision would be to chose the best portfolio out of the efficient set of given portfolio. Therefore, this particular theory is about diversification of risks by choosing the portfolio of assets having higher expected return and vice versa.

However, the relationship between the risk and return of portfolio of financial assets is explained using the theory or model of capital assets pricing model. This particular model introduce the risk free rate and investors are capable of leveraging their portfolio using riskless rate by buying more shares and short selling risk free rate in the market. By making investment in risk free rates, investors can also deleverage their investments. Diversification of unsystematic risks is the main reason that is associated with the formation of portfolio of financial assets. Nevertheless, due to presence of systematic risks, there cannot be complete elimination of risk factor. Investors would find it easy to diversify the risks associated with their portfolio of stocks is there is low coefficient between the portfolios of assets (Zabarankin et al. 2014).

The proxy risk free rate that is assumed in the model is 2.66%. Beta value of case company stood at 0.45% and the value of market risk premium is 6.5%. Value of beta of hypothetical company is -0.25%. It can be seen that the expected return of case company is 5.59% while that of hypothetical company is 1.04%. Hence, a case company stock is generating significantly higher return compared to hypothetical company. Variations in the portfolio can be reduced as per the theory by choosing assets class having low or negative covariance as costs can be reduced using such diversification measure.  

The value of beta depicts that security is not much volatile with respect to the market. Negative beta value of hypothetical company depicts that investment in stocks of such company would have movement that are in the opposite directions of the stock market. Therefore, it can be concluded as per the capital asset pricing model that the movement of value of portfolio is aligned with the market value. Beta value plays a considerable role in aligning the investment with risk profiles. Risk averse investors for avoiding excessive volatility and overweighing of portfolio, stocks with higher beta value is preferred by such inventors. When the stocks are put together in a portfolio, it is essential to consider the value of beta of each individual stocks (Dhrymes 2017). It is required to ensured by investors that computation of beta value is done by identifying the past price fluctuations. However, the security will move in the same direction cannot be ensured. For forecasting the portfolio value expected return value, it is essential to consider the value of beta. The portfolio of stocks of hypothetical company and case company comprise of equal proportion of shares. Investors are able to diversify the risks associated with the investment as the value of beta gets further reduced to -0.13 and 0.23 for hypothetical and case company. The value of portfolio beta is further reduced to 0.10 and the total expected return of portfolio stood at 3.31%. Therefore, it can be seen that forming the portfolio of financial assets helps in diversification of risks by reducing the value of beta and increasing the expected returns. However, since there are both systematic and unsystematic risks, assets diversification will help in reducing the systematic risks as against unsystematic risk that arises due to unavoidable external factors.

 

Bibliography:

Bloomberg.com. (2018). Australian Rates & Bonds. [online] Available at: https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia

Editorial, R. (2018). ${Instrument_CompanyName} ${Instrument_Ric} Quote| Reuters.com. [online] U.S. Available at: https://www.reuters.com/finance/stocks/overview/JBH.AX

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