a) You hold 10% bonds in a company which have a face value of $100 and 20 years to maturity. The bonds pay a coupon every year. The yield on bonds of companies with similar risk is currently 2% above the Australian 10-year government bond rate of 8.5%. You are offered the option of converting each bond you hold into a share which is expected to pay a dividend of $1.95 per share next year, and the dividends are expected to grow at approximately 2.5% every year. If shares in businesses of similar risk are currently trading at a discount rate of 4.5% p.a. nominal, should you accept the option? Why? 5 marks

b) Following are the price to earnings (P/E) ratios for two mining stocks:

P Ltd: P/E = (P/EPS) = 12.17

Q Ltd: P/E = (P/EPS) = 10.25

Is P Ltd underpriced or overpriced by the market relative to Q Ltd? Should you buy or sell Q Ltds share? 2 marks

c) Provide three hypothetical reasons why the P/E ratio of ANZ might differ from the P/E ratio of st. George bank in the most recent year. 3 marks

(Show all workings where applicable)