Question 2[20 Marks]

(a)Analyse the relationship between bond prices and interest rates during recession.

(4 Marks)

(b)An investor estimates that next year's net income for Hilary Pullman Hotel would be RM 8 million. The company has 0.5 million shares outstanding and decided to pay RM 0.5 million to the preferred stockholders from its net income. Listed companies similar to Hilary Pullman Hotel have been recently reported to have an average price/earnings ratio of 4 times. Given the information, calculate the expected price of the stock and evaluate the problems in using Price/earnings ratio method of valuing the shares of a company.

(6 Marks)

(c)East Boutique recently paid RM 1. 65 as an annual dividend. Future dividends are projected at RM 1.68, RM 1.72, RM 1.76 and RM 1.80 over the next four years,

respectively. Beginning five years from now, the dividend is expected to increase by 2.5 percent annually. Assess the worth of one share in this company if you require an 11 percent rate of return on similar investments.

(4 Marks)

(d)Which of the following bonds should an investor select, if the market interest rate were projected to fall by 50 basis point over the next six months? (Calculation for the percentage change in bond prices is required). (6 Marks)

(1) JK bond with a Macaulay duration of 9.5 years that's currently being priced to yield 10%.

(2) Super bond with a Macaulay duration of 8.7 years that's currently being priced to yield 5.8%.