A fixed interest security pays coupons of 5% per annum convertible half-yearly in arrears. The security is redeemable at 110% at the option of the borrower on any anniversary date between 15 and 25 years after the date of issue. An investor, who is liable to tax on income at a rate of 25% and on capital gains at a rate of 30%, intends to buy the product exactly two months after issue for a price that gives a net effective yield of at least 6% per annum. (i) Determine whether the investor would make a capital gain if the bond is held until redemption. (ii) In what way does your answer to part (i) affect the assumptions made for calculating the issue price? Explain in general terms the reasoning behind your chosen pricing approach. (iii) Calculate the maximum with-dividend price that the investor should pay per £100 nominal stock that guarantees a net effective yield of at least 6% per annum on this investment? (iv) The investor purchases the stock at the price calculated in part (iii). Assuming a constant inflation rate of 2.5% per annum, calculate the real rate of return achieved by the investor, should the borrower decide to redeem the loan exactly 20 years after issue.
A fixed interest security pays coupons of 5% per annum convertible half-yearly in arrears. The security is redeemable at 110% at the option of the borrower on any anniversary date between 15 and 25 years after the date of issue. An investor, who is liable to tax on income at a rate of 25% and on capital gains at a rate of 30%, intends to buy the product exactly two months after issue for a price that gives a net effective yield of at least 6% per annum. (i) Determine whether the investor would make a capital gain if the bond is held until redemption. (ii) In what way does your answer to part (i) affect the assumptions made for calculating the issue price? Explain in general terms the reasoning behind your chosen pricing approach. (iii) Calculate the maximum with-dividend price that the investor should pay per £100 nominal stock that guarantees a net effective yield of at least 6% per annum on this investment? (iv) The investor purchases the stock at the price calculated in part (iii). Assuming a constant inflation rate of 2.5% per annum, calculate the real rate of return achieved by the investor, should the borrower decide to redeem the loan exactly 20 years after issue.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Solve it using formulas, no tables
correct answers:
i) i^2 = 0.059126 > 0.0341
iii) P(wd) = £73.34 per £100 nominal
iv) using i* > 6% pa -->
f=2.5% --> i'= 3.72% pa
Transcribed Image Text:A fixed interest security pays coupons of 5% per annum convertible half-yearly in arrears.
The security is redeemable at 110% at the option of the borrower on any anniversary date
between 15 and 25 years after the date of issue.
An investor, who is liable to tax on income at a rate of 25% and on capital gains at a rate of
30%, intends to buy the product exactly two months after issue for a price that gives a net
effective yield of at least 6% per annum.
(i) Determine whether the investor would make a capital gain if the bond is held until
redemption.
(ii)
In what way does your answer to part (i) affect the assumptions made for calculating
the issue price? Explain in general terms the reasoning behind your chosen pricing
approach.
(iii) Calculate the maximum with-dividend price that the investor should pay per £100
nominal stock that guarantees a net effective yield of at least 6% per annum on this
investment?
(iv) The investor purchases the stock at the price calculated in part (iii). Assuming a
constant inflation rate of 2.5% per annum, calculate the real rate of return achieved
by the investor, should the borrower decide to redeem the loan exactly 20 years after
issue.
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