Question
Alice is a member on the investment committee of Wonderland Inc. The company is considering using $100,000 to create a 2-asset portfolio. The investment will
Alice is a member on the investment committee of Wonderland Inc. The company is considering using $100,000 to create a 2-asset portfolio. The investment will be divided into one stock and one bond. 35% of $100,000 is reserved for the stock and the remaining for the bond. As per the investment policy of the company, it is mandated as follows:
a) Only underpriced stocks should be a part of the portfolio
b) The bond with least duration should be a part of the portfolio Investors require a 12% return on stock and 6% return on bonds. The following stocks and bonds are competing to be a part of the portfolio:
i) Compute the price of all candidate stocks and indicate which of the three will be selected for the portfolio.
ii) Compute the duration of all candidate bonds and indicate which one will be selected for the portfolio.
iii) How many dollars will be allocated to the selected stock and bond? How many units of the selected stock and bond will be purchased?
STOCKS Details BONDS Details Stock 1 Bond 1 This bond has a face value of $5,000, pays an annual coupon of 3% and will mature in 5 years from now. Stock 2 Bond 2 This stock offers a constant dividend of $1.50 for an indefinite time period and its current market price is $15 This stock is expected to offer $1.50 as dividend next year and the growth rate in dividend is constant at 3% p.a. The current market price of this stock is $18 This stock is offering a current dividend of $1. Dividends for the next four years are likely to be $2, $2.5, $3.5 and $4 respectively, after which the dividend will grow at a constant rate of 1% p.a. The current market price of this stock is $30. This bond has a face value of $2,000 and offers no coupon payment. The maturity is 2 years from now. This bond has a face value of $1,000, pays a semi- annual coupon at the rate of 4% p.a. and has 3 years Stock 3 Bond 3 to mature. STOCKS Details BONDS Details Stock 1 Bond 1 This bond has a face value of $5,000, pays an annual coupon of 3% and will mature in 5 years from now. Stock 2 Bond 2 This stock offers a constant dividend of $1.50 for an indefinite time period and its current market price is $15 This stock is expected to offer $1.50 as dividend next year and the growth rate in dividend is constant at 3% p.a. The current market price of this stock is $18 This stock is offering a current dividend of $1. Dividends for the next four years are likely to be $2, $2.5, $3.5 and $4 respectively, after which the dividend will grow at a constant rate of 1% p.a. The current market price of this stock is $30. This bond has a face value of $2,000 and offers no coupon payment. The maturity is 2 years from now. This bond has a face value of $1,000, pays a semi- annual coupon at the rate of 4% p.a. and has 3 years Stock 3 Bond 3 to matureStep by Step Solution
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