Question 4 ( 25 marks) WSTB Ltd. has an outstanding issue of bond with a par value of $1,000, paying 8 percent coupon rate semi-annually. And, WSTB just paid a dividend of $2.70 per share. WSTB's dividends are expected to grow at 5.0 percent for next 2 years. i.e. year 1 and 2, and after year 2, dividends are estimated to grow at 4 percent thereafter forever. Based on current market information, government bond's yield for 10-year maturity is 5%, market expected return is 15%, and beta of WSTB's stock is 1.5. Assume no market friction and taxes. Required: (a) The bond of WSTB was issued 25 years ago, and has 5 years to maturity. What is the price and duration of the bond assuming 10 percent rate of current interest rate? (5 marks) (b) If interest rate is expected to decrease, what characteristics of bonds based on bond valuation would have better performance? (5 marks) (c) Assume that the forecasted dividends and the required rate of return are the same one year from now, as those forecasted today. What is the expected intrinsic value of the stock one year from now, just after the dividend has been paid in year one? (5 marks) (d) As an investor, you would like to include WSTB stock into your portfolio. However, based on your risk tolerance, you prefer a balance portfolio consisting of both WTSB's bond and stock. You have a 3 years financial plan to grow your current investment amount by compounding it at targeted rate of return 13% per annum. Assume the yield curve is flat and the risk perceived by investors on WSTB's stock is unchanged. Show your working how you could achieve your goal. (6 marks) (e) Show the steps how you carry out the portfolio management process. (4 marks) Question 4 ( 25 marks) WSTB Ltd. has an outstanding issue of bond with a par value of $1,000, paying 8 percent coupon rate semi-annually. And, WSTB just paid a dividend of $2.70 per share. WSTB's dividends are expected to grow at 5.0 percent for next 2 years. i.e. year 1 and 2, and after year 2, dividends are estimated to grow at 4 percent thereafter forever. Based on current market information, government bond's yield for 10-year maturity is 5%, market expected return is 15%, and beta of WSTB's stock is 1.5. Assume no market friction and taxes. Required: (a) The bond of WSTB was issued 25 years ago, and has 5 years to maturity. What is the price and duration of the bond assuming 10 percent rate of current interest rate? (5 marks) (b) If interest rate is expected to decrease, what characteristics of bonds based on bond valuation would have better performance? (5 marks) (c) Assume that the forecasted dividends and the required rate of return are the same one year from now, as those forecasted today. What is the expected intrinsic value of the stock one year from now, just after the dividend has been paid in year one? (5 marks) (d) As an investor, you would like to include WSTB stock into your portfolio. However, based on your risk tolerance, you prefer a balance portfolio consisting of both WTSB's bond and stock. You have a 3 years financial plan to grow your current investment amount by compounding it at targeted rate of return 13% per annum. Assume the yield curve is flat and the risk perceived by investors on WSTB's stock is unchanged. Show your working how you could achieve your goal. (6 marks) (e) Show the steps how you carry out the portfolio management process. (4 marks)
