QUESTION START

Duncan recently completed ACST1001 and is hoping to apply what he has learned to start investing.

The first investment he is considering is corporate bonds. Specifically, Duncan is interested in a $1,000 20-year semi-annual coupon bond with a coupon rate of 7%. The annual yield to maturity for such bonds is 5.5%.

a) Calculate the fair price Duncan should pay for one such bond, given market conditions.

b) Suppose that 6 months after he initially purchases this bond, immediately after receiving the coupon on that date, Duncan decides to sell his bond to his friend Ian. Ian pays a price that yields 6% p.a. effective. Calculate the price Ian paid, ignoring any other costs (such as brokerage).

c) Calculate the return on Duncans 6 month investment, expressed as a percentage.

d) Duncan has decided to purchase an ordinary share. He has predicted that the first dividend will be paid will be exactly two years from today, and amount to $5. From there, Duncan believes the dividend will grow at 20% p.a. for 3 years. After that, the share will grow at 2.5% p.a. indefinitely.

Based on the riskiness of this share, Duncan requires a return of 13% on his investment. Calculate the maximum price he is willing to pay for this share.

Duncan is also considering investing in shares in a new company, Greene Daeye Ltd. Duncan can buy either ordinary shares or preference shares.

e) Explain one difference between an ordinary share and a preference share. (1 mark)

f) Duncan has decided to purchase an ordinary share. He has predicted that the first dividend will be paid will be exactly two years from today, and amount to $5. From there, Duncan believes the dividend will grow at 20% p.a. for 3 years. After that, the share will grow at 2.5% p.a. indefinitely.

Based on the riskiness of this share, Duncan requires a return of 13% on his investment. Calculate the maximum price he is willing to pay for this share. (3 marks)

Please show worked answer, not on excel