Question 11

friends has approached you for advise as they have managed to raise $3,000 which they want to invest. They are looking at investing in one of the following:

• 3-year $100 government bond with annual payments of coupon at a rate of

  3.5% and redemption at par. Current yield to maturity of this bond is 4.8%

• Shares in a company where a relative of one of your friends works, for which they have collected the following information: o Most recently paid dividend: 64 pence o Expected growth rate of dividends: 2.5% o Required rate of return on the companys shares: 10.5%

  Required:

1. Calculate number of bonds and the number of shares the group can buy

   assuming they invest all their money on only one of these assets. (Assume they can also raise the additional cash required to buy a whole number of securities and indicate how much their full investment will be).

   (5 marks)

2. Explain why the required returns of the two securities are different, including a brief discussion of the three components of return an investor can expect to gain.

   8 marks