Question

5. The table below shows various bond prices at different maturity levels for zero coupon bonds. Based on this information, how would you describe the shape of the yield curve – is it: flat, upward sloping, downward sloping or there is not enough information present to make a determination? What does this shape mean? Note that the bonds all have $1,000 face value. maturity price

maturity	price
1	950.24
2	900.70
3	860.38
4	820.27

The current yields for zero-coupon bonds with varying maturities are outlined in the table below. What is the forward rate from the end of year 2 to the end of Year 3? What does this rate denote?

Maturity (Years)	Yield
1	2.75%
2	3.25%
3	3.65%
4	4.00%
5	4.15%

2. The nominal rate of interest is 6% and the real rate of interest is 3%. What is the expected inflation rate?

3. Jennifer and Tim are going skiing. Jennifer says to Tim, “I hope the curve of the ski hill corresponds to the slope of the curve that exists between bond prices and yields.” Tim looks puzzled and says, “I don’t want to ski uphill.” What do you think of Tim’s comment? Tim’ does not want them to increase.

Part B: Stock Markets and Share Pricing
(25 possible marks contributing to 8% of the total assignment weight)

4. JenniCo Inc. shares are trading for $500. Analysts expect the company to generate net income of $41.7 billion. JenniCo has 900 million shares outstanding. The average P/E ratio of JenniCo's competitors is 18. What is the fair price for a share of JenniCo?

5. Ivy Corp just paid out $1.7308B in dividends and repurchased $4.3983B worth of shares. Ivy has 1.12B shares outstanding. Ivy has told the market to expect total payouts to grow at an annual rate of 2%. Investors expect a 10% rate of return on Ivy shares. What is the Total Payout model estimate of the stock price today assuming that all payouts occur annually? (The next payout will occur in exactly one year.)

6. Assume that the industry average market-to-book ratio for the car industry is 3. Estimate the fair value of Madi Corp based on the industry average multiple and the data supplied below.

Maturity (Years)	Yield
1	2.75%
2	3.25%
3	3.65%
4	4.00%
5	4.15%

7. You are an investor considering the purchase of shares in Nanamobiles, a maker of specialty scooters. Shares of Nanmobiles are trading for $75 and its book value per share is $26.00. You have collected market-to-book information on Nanamobiles’ main competitors; this is in the table below. What is the fair value of Nanamobile shares and should you buy them?

	M/B
Grandpa Motors	3.5
Pops’ Scooter	2.4
Retired Roadmasters	3.0
Old Dog Enterprises	4.9

8. “All equity markets are efficient,” Sarah said. “I disagree,” said Chloe. “Large cap-markets are efficient – but small-cap markets are not,” she continued. Olivia went further. “What about developing country markets. I think these are not efficient.” What do you think? Is Sarah, Chloe or Olivia right? Or, are none of them right? Take a position and support it.

Answer 1

1. how would you describe the shape of the yield curve – is it: flat, upward sloping, downward sloping or there is not enough information present to make a determination?

The yield curve also is known as the term structure of interest rates is a graph that plots the similar-quality of bonds against their maturities ranging from shortest to longest.

Yield to maturity = (face value/current price of bond) ^ (1/years to maturity) - 1

1st maturity year interest rate = (1000/950.24)(1/1) -1= 105.23 = 5.23% interest rate

2nd maturity year = (1000/900.70) (1/1)-1 = 111.02 = 11.02%

3rd maturity year = (1000/860.38) (1/1) - 1 = 116.22 = 16.22%

4th maturity year = (1000/820.27) (1/1) - 1 = 121.91 = 21.91%

It is a normal yield curve which means upward sloping yield curve.

What does this shape mean?

If the short term is yield is lower than long term yields then the line is sloping upwards then the curve is referred to a positive or normal yield curve. Every maturity year the bond price is going down which means interest is increasing every year.

What is the forward rate from the end of year 2 to the end of Year 3?

MATURITY	YIELD	FORWARD RATE
1	2.75	n/a
2	3.25	3.75
3	3.65	4.75

A single 2 yr investment = A 1 yr investment + a 1 yr investment starting next year

3.25% + 3.25% = 2.75% + ?

6.5 = 2.75 + 3.75

A single 3 yr investment = A 2 yr investment + A 2 yr investment + a 1 yr investmennt starting 2 yrs from now

3.75 + 3.75 + 3.75 = 3.25 + 3.25 + ?

11.25 = 6.5 + 4.75

A forward rate represents the current expectations of a future bond interest rates.