Assignment of Fundamentals of Investment

Management

Submitted By:
Name: Pushkar Khanal
P.U. Regd. No. 2016-2-03-1053
Exam Roll No. 17032598
Program: BBA-7TH semester

Submitted To:
Mr. Kabiraj Khanal
Crimson College of Technology
Butwal-11, Devinagar, Rupandehi

May-15-2020

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 Section A (Very short Answer Questions)
1. Define investment management.
➢ Investment refers to money committed or property acquired for the future benefits. In
general terms, investment means the use of money in the hope of making more money. It
may be long-term. In finance, investment is the commitment of funds at present in some
course of action with the expectation of some positive rate of return. For eg. Deposit into
bank account, or place money into various investment alternatives.
Similarly, investment management refers to the management of the funds at various
investment alternatives so as to gain some positive rate of return in future. Additionally,
investment management is the professional asset management of various securities
(shares, bonds, and other assets e.g. real estate) in order to meet specified investment
goals for the benefit of the investors.
2. Differentiate between T-bills and CDs.
T-bills Certificate of Deposit (CDs)
It is issued by government. It is issued by BFIs and thrifts to raise funds
for financing their business activities.
It is a short-term security sold at low It is the evidence of deposit of funds in BFIs
transaction costs and with negotiable price for specified period of time at a specified rate
risk. of return.
T-bills are sold at discount from the par BFIs may sell CDs in denomination of Rs
value. 1000, Rs 5000, Rs 10000, Rs 100000 and
more.
T-bills have maturity less than one year. There is no limit on the maximum maturity.

3. Write any two names of Nepalese investment bankers.

➢ Two names of Nepalese investment bankers are as follows.
1. Siddhartha Capital
2. Global IME capital (Elite)
4. You have the following two alternative investments:
Security Expected Return Standard Deviation
A 10% 20%
B 15% 25%
In which security do you invest?
➢ Let’s compute the coefficient of variance (CV) to know the best investment alternatives
among two securities A & B.
𝜎 𝜎
𝐶𝑉𝐴 = 𝐸(𝑅𝐴 ) 𝐶𝑉𝐵 = 𝐸(𝑅𝐵 )
𝐴 𝐵
0.20 0.25
𝐶𝑉𝐴 = 0.10 𝐶𝑉𝐵 = 0.15
𝐶𝑉𝐴 = 2 𝐶𝑉𝐵 = 1.67

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 Decision: I will invest on security B because it has less risk associated i.e. 1.67 than
security A i.e. 2.
5. Write about systematic risk with examples.
➢ The risk that cannot be eliminated through diversification is called systematic risk. It is
also called non-diversifiable risk. It arises due to macroeconomic forces for instance,
business cycle, inflation, interest rates, foreign exchange rate, money supply, economic
growth and so on.
6. What is bond indenture?
➢ A bond indenture is a legal document or contract that contains terms and conditions of
bond issue. It includes details of debt issue, description of property pledge (if any), the
methods of principal repayment, restrictions (or covenants) placed on the firm by lenders,
rights and responsibilities of both borrower and lender.
7. Morning Star is expected to pay an annual dividend of $12 next year. Dividends have
been growing at a compound annual rate of 8% and are expected to continue to grow at
that rate. What is the value of a share of stock of Morning Star to an investor who
requires a 14% rate of return?
➢ Given,
Expected next year dividend (D1) = $12
Growth rate in dividend (g) = 8%
Investor’s required rate of return (ks) = 14%
The value of share of stock of Morning Star today (P0) is given by,

𝐷1 12
𝑃0 = 𝑃0 =
𝑘𝑠 −𝑔 0.14−0.08
𝑃0 = $200
Hence, the value of stock of Morning Star is $200.
8. Compute the value of the following bonds.
$1000 par value 7% coupon, perpetual bond if investor requires a 9% annual rate of return.
➢ Given,
Par value (M) = $1000
Coupon interest rate (i) = 7%
Investor required rate of return (Kd) = 9%
Value of a perpetual bond (V0) is given by,

𝐼 1000×0.07
V0 = 𝑘 V0 = V0 = $777.78
𝑑 0.09
Hence, value of perpetual bond is $777.78
9. Sketch one suitable example of SML in a graph.
➢ Sketch of Security Market Line (SML)
Let’s assume,
Expected return on asset A i.e. E(RA) = 9.75%

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 Expected return of market portfolio E(RM) = 11%
Risk free rate (RF) = 6%
Beta coefficient for asset A i.e. βA= 0.65
Market beta βM = 1
E(R) 𝑆𝑀𝐿
E(RM)=11%

E(RA)=9.75%

RF=6%

O βA= 0.65 βM = 1 Beta

10. What are inflation protected treasury bonds?

➢ Inflation protected treasury bonds are another variant of treasury securities. In U.S.A.,
they are called treasury inflation-protected securities or simply TIPS. Such securities are
coupon treasuries and commonly also known as treasury inflation indexed securities
(TIIS). Interest rate is set at fixed rate via auction process. And then principal amounts are
adjusted according to the inflation rate semiannually. Coupon rate is calculated on
inflation adjusted principal.

Section B
Descriptive Answer Questions
11. Identify different types of financial markets and the major participants in each of those
markets.
➢ Financial markets refer broadly to any marketplace where the trading of securities occurs,
including the stock market, bond market, forex market, and derivatives market, among
others. Financial markets are vital to the smooth operation of capitalist economies. People
and organizations wanting to borrow money are brought together with those having
surplus funds in the financial markets. Financial market allows transfers of funds from
person or business without investment opportunities to one who has it. In Financial
markets there is problem of imperfect information. Financial markets improve efficiency.
There are different types of financial markets depending on the financial instruments
being traded and the customer it serves
Types of Financial Markets
1. Physical Asset versus Financial Asset markets
➢ Physical asset markets (also called “tangible” or “real” asset markets) are those for
products such as wheat, autos, real estate, computers, and machinery.

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➢ Financial asset markets, on the other hand, deal with stocks, bonds, notes, mortgages, and
other claims on real assets, as well as with derivative securities whose values are derived
from changes in the prices of other assets.
2. Spot versus Future markets
➢ Spot markets are markets in which assets are bought or sold for “on-the-spot” delivery
(literally, within a few days).
➢ Futures markets are markets in which participants agree today to buy or sell an asset at
some future date.
➢ For example, a farmer may enter into a futures contract in which he agrees today to sell
5,000 bushels of soybeans six months from now at a price of Rs.500 a bushel. On the
other side, an international food producer looking to buy soybeans in the future may enter
into a futures contract in which it agrees to buy soybeans six months from now.
3. Money versus capital markets
➢ Money market is the market for trading short term securities. It involves trading of debt
instruments with original maturities of one year or less. Money market securities are
issued by high quality (that is low default risk) economic units such as governments,
financial institutions and other corporate organizations of sound financial standing that
require short-term funds. These securities are sold in large denominations and therefore
are purchased by economic units such as banks and other financial institutions and
corporate organizations that have excess short-term funds. Treasury bills, certificate of
deposit, commercial paper, bankers’ acceptance, Eurodollars etc. are issued in this market.
Most secondary market have active secondary market too provide liquidity. The chance of
default or loss of principal is very little in these securities. As a result, the rates of return
on money market securities are also very low.
➢ Capital market is the market for long-term securities issued by government and corporate
body to satisfy their long-term financing need. Capital market instruments have original
maturity over one year. Because of longer maturity, capital market instruments are less
liquid than the money market instruments. They are also exposed to interest rate risk or
maturity risk and are sold on higher yield basis as compared to money market instruments.
Capital market instruments include long-term securities like treasury notes and bonds
issued by government, corporate bonds, common stocks and preferred stocks issued by
corporations, municipal securities issued by local government authority and mortgages
and mortgage-backed securities.
4. Primary versus secondary markets
➢ Primary markets are the markets in which corporations raise new capital. If A company
wants to sell a new issue of common stock to raise capital, this would be a primary market
transaction. The corporation selling the newly created stock receives the proceeds from
the sale in a primary market transaction. IPO (Initial Public Offering) example of primary
market

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➢ Secondary markets are markets in which existing, already outstanding, securities are
traded among investors. The Nepal Stock Exchange (NEPSE) is a secondary market
because it deals in outstanding, as opposed to newly issued, stocks and bonds. Secondary
markets also exist for mortgages, various other types of loans, and other financial assets.
The corporation whose securities are being traded is not involved in a secondary market
transaction and, thus, does not receive any funds from such a sale.
5. Private versus public markets.
➢ In Private markets, transactions are negotiated directly between two parties. Bank loans
and private debt placements with insurance companies are examples of private market
transactions. Because these transactions are private, they may be structured in any manner
that appeals to the two parties. In public markets, standardized contracts are traded on
organized exchanges. Securities that are issued in public markets (for example, common
stock and corporate bonds) are ultimately held by a large number of individuals. Public
securities must have fairly standardized contractual features, both to appeal to a broad
range of investors and also because public investors do not generally have the time and
expertise to study unique, non-standardized contracts. Private market securities are more
tailor-made but less liquid, whereas publicly traded securities are more liquid but subject
to greater standardization.
Major participants in each of these markets
➢ Major participants in Money market
- Central Government
- State Government
- Public Sector Undertakings
- Scheduled Commercial Banks
- Private Sector Companies
➢ Major participants in Capital market
- Stock Exchange
- Retail Investors
- Institutional Investors
- Brokers and so on.
➢ Major participants in Future market vs Spot market
- broking members (deal for own account and/or for clients)
- non-broking members (deal for own account).
- foreign sector
- household sector (individuals)
- corporate sector
➢ Major participation in Private market
- Banks and financial intuitions
- Private organizations
- Household

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 ➢ Major participants in public market
- Banks and financial institutions
- Public organization and private corporation
- Government
➢ Major participants in financial assets market
- Stock exchange services
- Stock brokerages
- Electronic trading platforms
- Security dealers
- Financial institution
- Banks
➢ Major participants in Physical assets market
- Commodities dealers
- Processors (manufactures)
- Financial institutions
- Real estate companies.
➢ Major participants in Primary market
- Corporations investors
- Fund managers
- Investment bankers
- Individual investors
- Brokers and dealers
- Depositories

➢ Major participants in secondary market

- Members of the exchange (stockbrokers).
- Ultimate borrowers: corporate sector.
- Financial intermediaries.
- Ultimate lenders.
- Fund managers.
- Speculators and arbitrageurs
13. Consider the following information:
Stock price per share Rs.600
Margin requirement 50%
Interest rate on margin account 9%
Maintenance margin 30%
Ignoring transaction costs and taxes:
a. Assume that an investor takes a long position without using margin. Calculate the rate of
return if the stock is sold for Rs. 700 per share after one year.

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b. Assume that an investor takes a long position using margin (i) Calculate the stock price
that will trigger a margin call. (ii) Calculate the rate of return if the stock is sold for Rs.
700 per share after one year.
c. Explain why the rate of return using margin is different from the rate of return without
margin.
➢ Given,
Purchase/Beginning price per share (p0) = Rs 600
Initial margin requirement (IM) = 50%
Interest rate on margin account (i) = 9%
Maintenance margin (MM) = 30%
a) Calculation of rate of return that an investor takes a long position without using margin if
the stock sold for Rs 700 per share after one year
Ending price of share (P1) = Rs 700 per share

𝐸𝑛𝑑𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒−𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒 𝑃1 −𝑃0

𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = or,
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒 𝑃0
700 − 600
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 =
600

𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = 16.67%

b) i) Calculation of stock price that will trigger a marginal call

1−𝐼𝑀
𝑀𝑎𝑟𝑔𝑖𝑛 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 = × 𝑃0
1−𝑀𝑀

1 − 0.50
𝑀𝑎𝑟𝑔𝑖𝑛 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 = × 600
1 − 0.30

:- 𝑀𝑎𝑟𝑔𝑖𝑛 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 = 𝑅𝑠. 428.57

Thus, if the price falls below Rs. 428.57, a margin call will be made.
ii) Rate of return under long position with margin purchase
𝐸𝑛𝑑𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 + 𝑐𝑎𝑠ℎ 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 =
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑒𝑞𝑢𝑖𝑡𝑦

700 − 600 + 0 − 27
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 =
300

:-𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = 24.33%

Working note:1
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 = 𝑃0 × 𝑖 × (1 − 𝐼𝑀)
= 600 × 0.09 × (1 − 0.50)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 = 𝑅𝑠. 27

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 Working note:2
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑒𝑞𝑢𝑖𝑡𝑦 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝑃0 × 𝐼𝑀

= 600 × 0.50

𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑒𝑞𝑢𝑖𝑡𝑦 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝑅𝑠 300

c) The rate of return using margin is higher than the rate of return without using margin
because buying on margin allows investors to magnify the rate of return from the
expected increase in stock price. So, the rate of return using margin is differ than without
using margin.
14. Stock X and Stock Y have the following probability distributions of expected future
returns:

Probability 0.1 0.2 0.4 0.2 0.1

Stock X -10% 2 12 20 38

Stock Y -35% 0 20 25 45
a. Calculate expected return and standard deviation of returns on stock X.
b. Calculate expected return and standard deviation of returns on stock Y.
c. Calculate the coefficient of variation of returns on stock X and stock Y.
d. Is it possible that most investors might regard stock Y as being less risky than the
stock X? Explain.
➢ a) Calculation of expected return and standard deviation of return on stock X
i) Expected return in stock X i.e. E(RX)=?

𝑛 𝑛

𝐸(𝑅𝑥 ) = ∑ 𝑃𝑖 × 𝑅𝑗 , = ∑ 𝑃𝑖 × 𝑅𝑋
𝑖=1 𝑖=1
= 0.1 × (−10) + 0.2 × 2 + 0.4 × 12 + 0.2 × 20 + 0.1 × 38
= 12%
ii) Standard deviation of return on stock X i.e. (𝜎𝑥 ) =?
𝑛

𝜎𝑥 = √∑ 𝑃𝑖 × {𝑅𝑥 − 𝐸(𝑅𝑥 )}2

𝑖=1

𝜎𝑥 = √0.10 × (−10 − 12)2 + 0.2 × (2 − 12)2 + 0.4 × (12 − 12)2 + 0.2 × (20 − 12)2 + 0.1 × (38 − 12)2

:-𝜎𝑥 = 12.20%

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 b) Calculation of expected return and standard deviation of return on stock Y
i) Expected return in stock Y i.e. E(Ry)=?

𝑛 𝑛

𝐸(𝑅𝑦 ) = ∑ 𝑃𝑖 × 𝑅𝑗 , = ∑ 𝑃𝑖 × 𝑅𝑦
𝑖=1 𝑖=1
= 0.1 × (−35) + 0.2 × 0 + 0.4 × 20 + 0.2 × 25 + 0.1 × 45
= 14%
ii) Standard deviation of return on stock Y i.e. (𝜎𝑦 ) =?

𝜎𝑦 = √∑ 𝑃𝑖 × {𝑅𝑦 − 𝐸(𝑅𝑦 )}2

𝑖=1

𝜎𝑦 = √0.10 × (−35 − 14)2 + 0.2 × (0 − 14)2 + 0.4 × (20 − 14)2 + 0.2 × (25 − 14)2 + 0.1 × (45 − 14)2

:-𝜎𝑦 = 20.35%

c) Calculation of coefficient of variation (CV) of returns on stock X and stock Y.

𝜎 𝜎𝑦
𝐶𝑉𝑥 = 𝐸(𝑅𝑋 ) 𝐶𝑉𝑦 = 𝐸(𝑅
𝑋 𝑦)
12.20 20.35
𝐶𝑉𝑥 = 𝐶𝑉𝑦 =
12 14
𝐶𝑉𝑥 = 1.02 𝐶𝑉𝑦 = 1.45
d) No, it is not possible that most investors might regards stock Y as being less risky than stock X, it
is because the CV of stock Y is higher than the CV of stock X i.e. CVY > CVX. That means stock
Y is riskier in relative term because its coefficient of variance is higher than stock X, which
indicate that risk per unit of return for stock Y is more as compared to stock X.
15. Consider the following listing of stock traded in a stock exchange as on July 30, 2015.
Sym Close Chg Vol Div P/E Yld
NIBL 193 2.5 44235766 6.0 15.32 3.11
Required
➢ As above given information.
a) What was the firm’s closing price on previous day?
➢ The closing price on quoted date is Rs. 193 and previous closing price has been changed
by Rs 2.5. so,
𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑑𝑎𝑦′𝑠 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 = 193 − 2.5 = 𝑅𝑠. 190.5
b) How many shares could you buy for Rs. 50000?
𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 50,000
➢ 𝑁𝑜. 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒 𝑡ℎ𝑎𝑡 𝑖 𝑐𝑜𝑢𝑙𝑑 𝑏𝑢𝑦 = , = = 259 𝑠ℎ𝑎𝑟𝑒𝑠
𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 193
𝐻𝑒𝑛𝑐𝑒, 𝑡ℎ𝑒 𝑛𝑜. 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑡ℎ𝑎𝑡 𝑖 𝑐𝑜𝑢𝑙𝑑 𝑏𝑢𝑦 𝑎𝑟𝑒 259 𝑠ℎ𝑎𝑟𝑒𝑠.
c) What would be your annual dividend income from those shares?
➢ Dividend per share (DPS) = Rs. 6
Annual dividend income = 6 × 259 = Rs.1554

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 d) What must be NIBL’s earnings per share?
𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒
➢ P/E ratio=
𝐸𝑃𝑆
193
15.32=
𝐸𝑃𝑆

𝑝𝑟𝑖𝑐𝑒 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑟𝑎𝑡𝑖𝑜 (𝐸𝑃𝑆) = 𝑅𝑠 12.60

e) What do you mean by the ‘yld’?

➢ Yield refers to the earnings generated and realized on an investment over a particular
period of time. It's expressed as a percentage based on the invested amount, current
market value, or face value of the security. It includes the interest earned
or dividends received from holding a particular security. Here, in this question yld refers
to the dividend yield and it is calculated by,
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 6
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 = ,= , = 3.11%
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 193

16. Jaya Incorporation issued an 8% coupon, 30-year maturity bonds which has market value of
$ 1150 and is callable in 10 years at a call price of $1100.
➢ Given,
Coupon interest (i) = 8% = 0.08 × 1000 = $80
Maturity period (n) = 30 years
Market value of bond (V0) = $ 1150
Call period (t) = 10 years
Call price = $ 1100
a) What is its yield to maturity?
➢ 𝑌𝑇𝑀 =?
𝑉0 = 𝐼 × 𝑃𝑉𝐼𝐹𝐴𝑌𝑇𝑀%,𝑛 + 𝑀 × 𝑃𝑉𝐼𝐹𝑌𝑇𝑀%,𝑛
(𝑀 − 𝑉0 )
𝐼+ 𝑛
𝐴𝑝𝑝𝑟𝑜𝑥𝑖𝑚𝑎𝑡𝑒 𝑌𝑇𝑀 =
𝑀 + 2𝑉0
3

(1000 − 1150)
80 +
= 30
1000 + 2 × 1150
3
75
= , 𝐴. 𝑌𝑇𝑀 = 6.82%
1100

By interpolation,

𝑉𝐿𝑅 − 𝑉𝑇𝑅
𝑌𝑇𝑀 = 𝐿𝑅 + (𝐻𝑅 − 𝐿𝑅)
𝑉𝐿𝑅 − 𝑉𝐻𝑅

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 1275.82 − 1150
=6+ (7 − 6)
1275.28 − 1124.12
𝑌𝑇𝑀 = 6.83%

Hence, yield to maturity (YTM) is 6.83%

Working note:

𝑉0 @ 𝑇𝑅 = $1150

𝐿𝑅 = 6%

𝐻𝑅 = 7%

𝑉0 @6% = 𝐼 × 𝑃𝑉𝐼𝐹𝐴𝑌𝑇𝑀%,𝑛 + 𝑀 × 𝑃𝑉𝐼𝐹𝑌𝑇𝑀%,𝑛

= 80 × 𝑃𝑉𝐼𝐹𝐴6%,30 + 1000 × 𝑃𝑉𝐼𝐹6%,30

= 80 × 13.7648 + 1000 × 0.1741

= $1275.28

𝑉0 @7% = 𝐼 × 𝑃𝑉𝐼𝐹𝐴𝑌𝑇𝑀%,𝑛 + 𝑀 × 𝑃𝑉𝐼𝐹𝑌𝑇𝑀%,𝑛

= 80 × 𝑃𝑉𝐼𝐹𝐴7%,30 + 1000 × 𝑃𝑉𝐼𝐹7%,30

= 80 × 12.4090 + 1000 × 0.1314

= $1124.12

b) What is its yield to call (YTC)?

(𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒−𝑉0 )
𝐼+
𝑡
➢ 𝐴𝑝𝑝𝑟𝑜𝑥𝑖𝑚𝑎𝑡𝑒 𝑌𝑇𝐶 = 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒+2𝑉0
3

(1100 − 1150)
80 +
= 10 , 𝐴. 𝑌𝑇𝐶 = 6.62%
1100 + 2 × 1150
3
By applying interpolation formula,

𝑉0 @ 𝐿𝑅 − 𝑉0 @ 𝑇𝑅
𝑌𝑇𝐶 = 𝐿𝑅 + (𝐻𝑅 − 𝐿𝑅)
𝑉0 @ 𝐿𝑅 − 𝑉0 @ 𝐻𝑅
1203.04−1150
= 6 + 1203.04−1121.01 (7 − 6)

12
 𝑌𝑇𝐶 = 6.65%

Hence, yield to call (YTC) is 6.65%

Working note:

𝑉0 @ 𝑇𝑅 = $1150

𝐿𝑅 = 6%

𝐻𝑅 = 7%

𝑉0 @6% = 𝐼 × 𝑃𝑉𝐼𝐹𝐴𝑌𝑇𝐶%,𝑡 + 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 × 𝑃𝑉𝐼𝐹𝑌𝑇𝑐%,𝑡

= 80 × 𝑃𝑉𝐼𝐹𝐴6%,10 + 1100 × 𝑃𝑉𝐼𝐹6%,10

= 80 × 7.3601 + 1100 × 0.5584

= $1203.04

𝑉0 @7% = 𝐼 × 𝑃𝑉𝐼𝐹𝐴𝑌𝑇𝐶%,𝑡 + 𝑐𝑎𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 × 𝑃𝑉𝐼𝐹𝑌𝑇𝑐%,𝑡

= 80 × 𝑃𝑉𝐼𝐹𝐴7%,10 + 1100 × 𝑃𝑉𝐼𝐹7%,10

= 80 × 7.0236 + 1100 × 0.5083

= $1121.01

c) In what situation the bond is likely to call? Explain.

➢ 1. Relief from interest
• Bond is usually called before its maturity to lessen the interest that will be paid in the
future. It is because, from the issuer’s point of view, it is more advantageous for them
to redeem the bond early, paying a call premium than to wait for its maturity where
they will be required to pay interest periodically.
2. Rescue from obligation
• Bond is actually an obligation in writing. Every issuer is required to redeem the bond
at its maturity date. Maturity date is the date when the bond is called for payment and
cancellation. Interest is also paid periodically until its maturity. So, to be rescue from
obligation the bond is call before maturity.
3. Due to insolvency
• Due to insolvency of the issuer’ and buyer, the bond is called before maturity. It is
because if either party realize that they are going to be solvent, they called the bold
before maturity.

13
17. Kantipur Publication recently paid a dividend i.e. D0 of Rs. 12.5. The company expects to
have supernormal growth of 20% for the 2 years before the dividend is expected to grow at a
constant rate of 5%. The firm’s cost of equity is 10%.
➢ Given
Paid dividend (D0) = Rs 12.5
Growth rate (g) = 20% for 2 years before constant growth
Constant growth (gc) = 5% after 2 years
Cost of equity/required rate of return (KS) = 10%

Via timeline figure:

g = 20%

0 1 2
gc = 5%

a) What year is the terminal or horizon date?

➢ The terminal or horizon date is the date when the growth rate becomes constant. This
occurs at the end of year 2.
b) What is the stock’s horizon or terminal value?
➢ The horizon or terminal value is the value of stock at the horizon date.
Here,

𝐷2 (1+𝑔𝐶 )
𝐻𝑜𝑟𝑖𝑧𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 𝑜𝑟 𝑃2 = , {Horizon date is at the end of year 2.}
𝐾𝑆 −𝑔𝐶

𝐷1 = 𝐷0 (1 + 𝑔) , = 𝑅𝑠 12.5(1 + 0.20), = 𝑅𝑠 15

𝐷2 = 𝐷1 (1 + 𝑔) , = 𝑅𝑠 15(1 + 0.20) , = 𝑅𝑠 18

𝐷3 = 𝐷2 (1 + 𝑔𝐶 ) , = 𝑅𝑠 18(1 + 0.05), = 𝑅𝑠 18.9

Now,

𝐷3 18.9
𝑃2 = ,= , = 𝑅𝑠 378
𝐾𝑠 − 𝑔𝐶 0.10 − 0.05

Hence, Horizon or terminal value is Rs 378.

c) What is the stock’s intrinsic value today?

➢ The stock’s intrinsic value (P0) is calculated as the sum of the present value of all dividends during
the supernormal growth period plus the present value of the horizon value.

14
 𝐷1 𝐷2 𝑃2
𝑃0 = 1
+ 2
+
(1 + 𝐾𝑆 ) (1 + 𝐾𝑆 ) (1 + 𝐾𝑆 )2

15 18 378
= + 2
+
1.10 (1.10) (1.10)2

= 𝑅𝑠 340.92

Hence, stock’s intrinsic value (P0) is Rs 340.92

Section C
18. Read the following case and answer the following questions. 20
George Hada, a Nepali stock market investor, is interested to analyze the general behavior of stock
market in Nepal over the years. For this purpose, he has decided to use several methods of
constructing stock market index. Upon careful analysis of different sector’s enterprises listed in
Nepalese stock market, he has decided to include sample of six stocks in index construction that are
representatives of the universe of stock market in Nepal. Further, he plans to use July 15, 1995, his
birthday, as the base, and is interested in measuring the value of the average or the index on July 15,
2010 and July 15, 2016. He has found the closing prices for each of the six stocks, 1 through 6, at
each of the three dates. Note that the number of shares of outstanding as on July 15, 1995 is 1000
shares for each stock 1 through 3, and 2000 shares for each stock 4 through 6. Assume that number of
outstanding shares of these stocks did not change since the base period.
Stocks Closing Stock Price
July 15, 2016 July 15, 2010 July 15, 1995
1 Rs. 360 Rs. 350 Rs. 150
2 320 360 200
3 200 430 220
4 780 500 210
5 1020 710 425
6 320 220 340
On the basis of stock price data for six stocks on three dates, you are required to work out stock
market index under the following situations.
d) Given,
Stocks Closing price No of. Outstanding shares
July15,2016 July15,2010 July15,995
1 Rs 360 Rs 350 Rs 150 1000
2 320 360 200 1000
3 200 430 220 1000
4 780 500 210 2000
5 1020 710 425 2000
6 320 220 340 2000

15
 Base period = July15,1995
Divisor = No. of stock = 6
a) Calculate Dow Jones Industrial Average/Price Weighted Index based on the above
information. i.e. Price Weighted Index (PWI) =?

𝑇𝑜𝑡𝑎𝑙 𝑜𝑓 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑒𝑎𝑐ℎ 𝑠𝑡𝑜𝑐𝑘

➢ i) 𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,1995 = 𝐷𝑖𝑣𝑖𝑠𝑜𝑟

150 + 200 + 220 + 210 + 425 + 340

=
6

𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,1995 = 257.50

𝑇𝑜𝑡𝑎𝑙 𝑜𝑓 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑒𝑎𝑐ℎ 𝑠𝑡𝑜𝑐𝑘

ii) 𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,2010 =
𝐷𝑖𝑣𝑖𝑠𝑜𝑟

350 + 360 + 430 + 500 + 710 + 220

=
6
𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,2010 = 428.33

𝑇𝑜𝑡𝑎𝑙 𝑜𝑓 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑒𝑎𝑐ℎ 𝑠𝑡𝑜𝑐𝑘

iii) 𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,2016 = 𝐷𝑖𝑣𝑖𝑠𝑜𝑟

360 + 320 + 200 + 780 + 1020 + 320

=
6
𝑃𝑊𝐼𝐽𝑢𝑙𝑦,15,2016 = 500

b) Calculate Standard and Poor (S&P500)/NEPSE Index based on the above information. i.e
Value weighted Index (VWI)=? and NEPSE Index=?

𝑆𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑙𝑙 𝑠𝑡𝑜𝑐𝑘𝑠 𝑖𝑛 𝐽𝑢𝑙𝑦15,2010

➢ i) 𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2010 = × 10
𝑆𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑙𝑙 𝑠𝑡𝑜𝑐𝑘𝑠

350 × 1000 + 360 × 1000 + 430 × 1000 + 500 × 2000 + 710 × 2000 + 220 × 2000
= × 10
150 × 1000 + 200 × 1000 + 220 × 1000 + 210 × 2000 + 425 × 2000 + 340 × 2000
4000000
= × 10
2520000

𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2010 = 15.87

16
 𝑆𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑙𝑙 𝑠𝑡𝑜𝑐𝑘𝑠 𝑖𝑛 𝐽𝑢𝑙𝑦15,2016
ii) 𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2016 = 𝑆𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑙𝑙 𝑠𝑡𝑜𝑐𝑘𝑠
× 10

360 × 1000 + 320 × 1000 + 200 × 1000 + 780 × 2000 + 1020 × 2000 + 320 × 2000
= × 10
150 × 1000 + 200 × 1000 + 220 × 1000 + 210 × 2000 + 425 × 2000 + 340 × 2000
5120000
= × 10
2520000

𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2016 = 20.32

NEPSE Index
𝑆𝑢𝑚 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑎𝑠 𝑜𝑛 𝐽𝑢𝑙𝑦15,2010
iii) 𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2010 = × 100
𝑆𝑢𝑚 𝑜𝑓 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑎𝑠 𝑜𝑛 𝐽𝑢𝑙𝑦15,1995

350 × 1000 + 360 × 1000 + 430 × 1000 + 500 × 2000 + 710 × 2000 + 220 × 2000
= × 100
150 × 1000 + 200 × 1000 + 220 × 1000 + 210 × 2000 + 425 × 2000 + 340 × 2000
4000000
= × 100
2520000

𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2010 = 158.73

𝑆𝑢𝑚 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑎𝑠 𝑜𝑛 𝐽𝑢𝑙𝑦15,2016

iv) 𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2016 = 𝑆𝑢𝑚 𝑜𝑓 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑎𝑠 𝑜𝑛 𝐽𝑢𝑙𝑦15,1995 × 100

360 × 1000 + 320 × 1000 + 200 × 1000 + 780 × 2000 + 1020 × 2000 + 320 × 2000
= × 100
150 × 1000 + 200 × 1000 + 220 × 1000 + 210 × 2000 + 425 × 2000 + 340 × 2000

5120000
= × 100
2520000

𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2016 = 203.17

c) Predict the market behavior bull or bear based on the information

➢ To proof market condition, we can go through percentage change in average market index.

For PWI

𝑃𝑊𝐼𝐽𝑢𝑙𝑦15,2016 − 𝑃𝑊𝐼𝐽𝑢𝑙𝑦15,2010 500 − 428.33

% 𝐶ℎ𝑎𝑛𝑔𝑒 = , = , = 16.73%
𝑃𝑊𝐼𝐽𝑢𝑙𝑦15,2010 428.33

17
 According to VWI

𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2016 − 𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2010 20.32 − 15.87

% 𝐶ℎ𝑎𝑛𝑔𝑒 = , = , = 28.04%
𝑉𝑊𝐼𝐽𝑢𝑙𝑦15,2010 15.87

According to NEPSE Index

𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2016 − 𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2010 203.17 − 158.73

% 𝐶ℎ𝑎𝑛𝑔𝑒 = , = , = 28%
𝑁𝐸𝑃𝑆𝐸 𝐼𝑛𝑑𝑒𝑥𝐽𝑢𝑙𝑦15,2010 158.73

Hence, according to this calculation the % change in index is positive so, this is bull market.

THE END

THANK YOU

18