Semester “Fall 2010”

“Money & Banking (MGT411)”

Assignment No. 01
Marks: 15
Question no 1

Part (a)
On 01 January 2010 JS Group want to issue bonds in the capital
market having
face value Rs.1, 000 with coupon rate of 10% (semi annually and 15
years
maturity). Investor required rate of return in this scenario is 12%.
You are being the student of finance know the worth of fundamental
methods of
valuation; therefore you are required to calculate the present value of
the bond by
utilizing the fundamental methods.
Part (b)
The bond of JS Group is traded in the Karachi Stock exchange for
Rs.950. The
par value of the bond is Rs.1, 000. The coupon rate is fixed at 12 %
paid annually.
This bond will be matured after 03 year. What will be (YTM) of this
bond?
Part (c)
EFU, an insurance company, wants to plan a new service to its policy
holders.
During the meeting of executives, CEO offered a plan of house
insurance. The
summary of estimated cash flows which were discussed in that
meeting is:
• This project will need Rs.05 million as initial investment
• In the first year company will receive Rs.02 million as premium from
the
policy holders.
• In second year, company expect to receive Rs.2.5 millions as
premium
• In third year company estimated that it will have to receive only Rs.
01
million because there will be a earth quack in that period, as
probability of
having earth quack is more than 80% as predicted by geologists.
• In the fourth year the company estimated to get Rs.1.5 million after
clearing
the insurance claims of the policy holders.
• In fifth year they expect to receive only Rs. 0.5 million
Calculate the IRR of above mentioned plan by trail and error method?
Solution;
PART A.
FOR CALCULATING A PRESENT VALUE OF A BOND

C C C M
Pv = + + ................. +
(1 + rd ) (1 + rd ) 2
(1 + rd ) (1 + rd )n
n

n
C M
Pv = ∑ +
( 1 + rd ) ( 1 + rd )
t n
t =1

 1 
 1− n 

Pv = C 
( 1 + rd )  + M
 rd  ( 1 + rd ) n
 
 
Where
C=interest paid each year =coupon rate*face value
C=10%*1000
C=100
AND for semiannually it will be INT=100/2=Rs.50

And n=number of PERIODDS

Here n=15 years and for semiannually it will be n=15*2=30

Rd=rate of return that is =12%

And for semiannually it will be =12/2=6%
And M= face or par value

 1 
 1− n 

Pv = C 
( 1 + rd )  + M
 rd  ( 1 + rd ) n
 
 
By putting the Values

 1 
 1− 
( 1 + 0.06 )
30

Pv = 50   + 1000
 0.06  ( 1 + 0.06 ) 30
 
 
  1 
 1 − 5.7434  1000
Pv = 50  +
 0.06  5.7434
 

 0.825  1000
Pv = 50  +
 0.06  5.7434

Pv = 862.35

Pv = Rs.862.35

So the present value of BOND will be RS.862.35

PART.B.
For calculating YTM ,USING APPROXIMATION FORMULA ….

I + ( V − P) / T
YTM =
( V + P) / 2
Where
I= annual coupon interest payment
That will be
=coupon rate*face value
=12/100*1000
=120
=Rs.120
And
V=par value
=1000
And
P=price of the bond
=Rs.950
T=number of time period involved
=3

By putting the values

 120 + ( 1000 − 950 ) / 3
YTM =
( 1000 + 950 ) / 2

120 + ( 50 ) / 3
YTM =
( 1950 ) / 2

YTM = 0.14017
= 14..017 %

C)
Cash flow for EFU, INSURANCE COMPANY

0 1 2 3 4 5

- 5 million +2million +2.5 +1 million +1.5 + 0.5

By using the formula of present value

1 2 3 4 5
 1   1   1   1   1 
PV = CF1   + CF2   + CF3   + CF 4   + CF 5  
 1 + IRR   1 + IRR   1 + IRR   1 + IRR   1 + IRR 
USING TRILE AND ERROR METHOD
LET SUPPOSE we consider IRR=20%
BY PUUTING THE VALUES
1 2 3 4 5
 1   1   1   1   1 
5 = 2  + 2.5   + 1  + 1.5   + 0.5  
 1 + 0.2   1 + 0.2   1 + 0.2   1 + 0.2   1 + 0.2 
5 = 1.166666667 + 1.73611111 + 0.57870370 + 0.72337963 + 0.20093879
5 = 4.905799

It means that IRR WILL BE a slightly low

Now put the IRR=18%

1 2 3 4 5
 1   1   1   1   1 
5 = 2  + 2.5   + 1  + 1.5   + 0.5  
 1 + 0.18   1 + 0.18   1 + 0.18   1 + 0.18   1 + 0.18 
5 = 1.69491525 + +1.79546107 + 0.60863087 + 0.77368331 + 0.21855461
5 = 5.09124511

It means that IRR will be between 18 and 20%

Now put the value of IRR=18.90%
1 2 3 4 5
 1   1   1   1   1 
5 = 2  + 2.5   + 1  + 1.5   + 0.5  
 1 + 0.189   1 + 0.189   1 + 0.189   1 + 0.189   1 + 0.189 
5 = 1.68208579 + 1.76838287 + 0.59491434 + 0.75052271 + 0.21040726
5 = 5.00 ( APPROXIMATLY )

SO THE IRR will be 18.90%