Bond and Equity Analysis Exam
Answer all questions -
Question 1 -
Assume that you are managing a portfolio of bonds for a client. Using the internet, select any five corporate bonds with maturities ranging from shorter to longer and note their price, coupon rate and time to maturity. Assume that all coupons are paid semi-annually, the par value for all the bonds is 100, and the settlement date is the date you have collected the bond's prices.
Write a report to your client in which you will cover the following points:
i) Find the current yield, yield to maturity, duration, modified duration and convexity for each bond. Present your bond characteristics and findings to the client and give clear but concise explanations of what each of them means.
ii) Assume the length of your client's investment horizon (for example 5 years) and the level of their required yield (for example 5% p.a). Immunise his portfolio from interest rate risk and reinvestment risk, while maintaining the level of the desired yield in your portfolio. Short-selling of bonds is allowed and your portfolio composition should be as realistic as possible. Explain the choice of any short-selling restriction applied, the benefits of the investment strategy applied in this question and present your portfolio to the client.
iii) If interest rates fall by 100 bps, how much (in %) will the value of your portfolio change? Explain your answer, commenting on the type of measures you've used to determine the percentage change in portfolio value and their appropriateness.
Question 2 -
The following are some historical P/E ratios for a group of Asian markets, with relevant information on interest rates, inflation and economic growth:
|
Emerging Market
|
P/E Ratio
|
Interest Rate
|
Inflation
|
Real GDP Growth
|
|
China
|
18.0
|
10.00%
|
17.6%
|
12.1%
|
|
Hong Kong
|
18.1
|
2.28%
|
6.2%
|
5.5%
|
|
India
|
26.6
|
5.27%
|
8.6%
|
4.5%
|
|
Indonesia
|
24.1
|
3.50%
|
8.4%
|
6.1%
|
|
Malaysia
|
34.6
|
7.00%
|
3.4%
|
8.1%
|
|
Philippines
|
21.5
|
9.00%
|
9.1%
|
2.1%
|
|
Singapore
|
26.2
|
1.50%
|
2.8%
|
10.7%
|
|
South Korea
|
22.0
|
7.90%
|
5.8%
|
6.5%
|
|
Taiwan
|
34.0
|
4.13%
|
2.9%
|
6.1%
|
|
Thailand
|
23.5
|
3.00%
|
4.9%
|
7.5%
|
The relationship between P/E ratios and relevant variables is given in the following regression equation:
P/E = 26.64 + 80.1 x Interest rate - 120.78 x Inflation + 33.95 x Real GDP Growth
Based upon the regression, which markets are under and overvalued? Explain your answer and discuss why regression-based valuation is not used as often as valuation based on comparables. Compare the two approaches.
Question 3 -
One of the most famous investors, Warren Buffet, has said on a number of occasions that derivatives are "time bombs". In contrast, many market participants would argue that derivatives contribute to risk management. Critically evaluate both views, using examples wherever possible.