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Question #8 Adam is a first-year student at the University and has approached Nancy’s office for...

Question #8

Adam is a first-year student at the University and has approached Nancy’s office for a summer internship. Nancy will have to assign him to a project over the summer and he would need to submit a written report to Nancy and his professor as a part of his coursework. Before agreeing to accept Adam for a summer internship, she desires to test his knowledge with a few questions and tells him that he needs to get at least three out of the following five questions correct in 45 minutes so as to be eligible for selection as an intern.
1. A 7% annual coupon bond is available for purchase today at a price of $800. It is expected that in 5 years’ time, it will sell for $920. If you buy this bond today and sell it after 5 years, what will be your 5-year return, assuming that all received coupon payments are periodically reinvested at a rate of 6% p.a.? Also, calculate the annualized return for your investment in this bond.

2. A stock is trading for $25 per share, has an expected dividend of $1 per share and a growth rate of 7%. Will you buy the stock if your required return is 10%?

3. A 20-year, 9% coupon bond has a YTM of 12%. If you are subject to a 25% tax rate, what is your actual YTM on this bond after incorporating the effect of taxes?

4. Why should a company be concerned with how its shares perform on the secondary market?

5. What is the purpose of a stock market index? Name two international and one local stock market index.

In about an hour, Adam submits the following answers to these questions and Nancy conveys her decision to him.
1. 5-year return = 15%, Annualized return = 3%

2. Expected Return of the stock = 11%. Alternatively, Price = $33.33, Therefore, the stock can be purchased.

3. YTM = 10.5%

4. A company should be concerned with the performance of its shares in the secondary market because it gets capital from there. If the shares do not perform well, the company will fall short of its capital requirements.

5. A stock market index allows investors to know which shares should be bought and sold. I cannot think of any examples at the moment. Sorry.


After Adam’s evaluation, Nancy steps out of her office for an investor meeting, for which she is already late. Adam had taken more than 45 minutes to submit his responses and that has disturbed her schedule.

Question 8
Evaluate all responses offered by Adam. For correct responses, tell him why is he correct. For wrong responses, tell him why is he wrong. Show all your computations and arguments. Did Adam succeed in procuring the internship?
(5 + 5 + 5 + 5 + 5 = 25 marks)

Solutions

Expert Solution

4) he is not correct that company gets capital from the secondary market, secondary market is a place where securities are bought and sold by investors where the company is not receiving the capital but secondary market performance of stock is a barometer of how the company is doing financially so if the stock price is not doing well then there is high probability the company financial position is not very strong.

5) The stock market index act as a barometer as to how the underlying market is doing not just for buying and selling securities, the platform provided by exchange is the place where you can buy and sell securities. Major international Indexes are EURO STOXX 50, FTSE EURO FIRST. In US the major indexes are S&P 500 and DJIA.


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