1.

If we have $1,000 today that we put in an exchange-traded fund that will generate
12% per year for the next two years, how much will we have in the account in two
years?

2. How much a recurring investment of Rs. 10000 per annum accumulates to at the
end of 30 years where the investment fetches an interest rate of 9.5% per annum if
compounding is: (a) annual, (b) quarterly and (c) monthly?

FV Annual Compounding 1496875.022

FV quarterly compounding 1654872.604

FV monthly compounding 1694195.979

Base formula: =pmt*((1+r)^n-1)/r= 10000*((1+0.095)^30-1)/0.095

3. Suppose a bank is selling a series of 10 annual cash flows of $1000 for $5000
today and assume that interest rate will remain at 8% for the entire period. Is it
worthwhile to make such an investment?

Ans: PVA= PMT*((1-1/(1+r)^n)/r =1000*(1-(1/(1+8%)^10)/8%)=6710.0814

4. A finance firm has announced a scheme called "lakhpati" in 10 years. It has

promised to pay Rs.100000 after 10 years for every Rs. 20000 deposited today.
The ad also states that the firm pays Rs.80000 as interest and therefore offers a
40% annual return. Do you agree with the claim made in the scheme. Explain.
What would be the maturity value if the finance firm really had to offer 40%
annual return?
5. Mr. Warren Buffet in June 2006 decided to donate 85% of his $44 billion fortune
to Bill and Melinda Gates Foundation in installments of $1.5 billion every year. If
Mr. Buffet did not impose any stipulation and instated the Foundation decided to
invest the annual contribution at 8% and spend the aggregate sum only upon
receiving the entire contribution promised, what amount will the foundation have
at the end? Do you think that Mr. Buffet has really donated 85% of his fortune to
the gates Foundation?? If not, what is the % of wealth he has really donated to the
foundation assuming that he earns 8% on his wealth???
6. Suppose you are currently at 55 years old and intend to retire at 60. To make your
retirement life smooth you deposit a specific amount on 55th , 56th , 57th and 58th
year in a bank that fetches you 8% year. After retirement, you anticipate to live
upto 68th year. At the beginning of 61st year you started withdrawing 30000 each
year. How much money must be there in your account at the time of your heavenly
abode?
7. Suppose TATA steel Chairman wishes to endow a chair in finance at XLRI.
Finance Controller at XLRI indicated that it requires $200,000 p.a. to support the
chair and the endowment would earn @10% p.a. Determine how many $ TATA
Steel should fund the Chair so as to retain the chair for indefinite period.
8. Suppose TATA steel Chairman wishes to endow a chair in finance at XLRI.
Finance Controller at XLRI indicated that it requires $200,000 p.a. to support the
chair and the endowment would earn @10% p.a. Apart from the above,
endowment chair expenses expected to grow at the rate of 5% beyond the first
year. Determine how many $ TATA Steel should fund the Chair so as to retain the
chair for indefinite period.
9. Suppose I want to be able to withdraw Rs. 5,000 at the end of 5 years and Rs.
10,000 at the end of six years, leaving a zero balance in the account at the end of
six years. If I can earn 5% interest rate per annum in my balances, how much I
should deposit today in the bank today to satisfy my future withdrawal need?
10. Company X wants to determine the most it pay to purchase a particular ordinary
annuity. The annuity consists of cash flow of $700 for five years. The firm
requires the annuity to provide a minimum return of 8%. Find the present value of
the ordinary annuity?

Bond Valuation
1. Assume you have the following information.
Suppose XYZ company bond have a $1,000 face value
The promised annual coupon is $100
The bonds mature in 20 years
The market’s required return on similar bonds is 10%
a. Calculate the present value of the face value

= $1,000 [1/1.1020 ] = $1,000 .14864 = $148.64

b. Calculate the present value of the coupon payments
= $100 [1 - (1/1.1020)]/.10 = $100 8.5136 = $851.36
 c. Bond Value = $148.64 + 851.36 = $1,000

2. Suppose a bond currently sells for $932.90. It pays an annual coupon of $70, and it
matures in 10 years. It has a face value of $1000. What are its coupon rate, current
yield, and yield to maturity (YTM)?
a. The coupon rate (or just “coupon”) is the annual dollar coupon expressed as a
percentage of the face value:
Coupon rate = $70 /$1000 = 7%
b. The current yield is the annual coupon divided by the current market price of
the bond:
Current yield = $70 /932.90 = 7.5%
c. Under what conditions will the coupon rate and current yield be the same?

3. An MBA intern is given a task by a portfolio manager to evaluate two par value
bonds, where Bond A has a 4% coupon and Bond B has a 10% coupon. Both have
10 years to maturity, make semiannual payments, and have 9% YTMs. If market
rates rise by 2%, what is the percentage price change of these bonds? If rates fall
by 2%, what does this say about the risk of lower-coupon bonds?

Current Prices:

Bond J:

PV = $20 [1 - 1/(1.045)20]/.045 + $1,000/(1.045)20

= $______

Bond K:

PV = $50 [1 - 1/(1.045)20]/.045 + $1,000/(1.045)20

= $1065.04

Prices if market rates rise by 2%:

Bond J:

PV = $20 [1 - 1/(1.055)20]/.055 + $1,000/(1.055)20

 = $581.74

Bond K:

PV = $50 [1 - 1/(1.055)20]/.055 + $1,000/(1.055)20

= $______

Prices if market rates fall by 2%:

Bond J:

PV = $20 [1 - 1/(1.035)20]/.035 + $1,000/(1.035)20

= $786.82

Bond K:

PV = $50 [1 - 1/(1.035)20]/.035 + $1,000/(1.035)20

= $1213.19

Percentage Changes in Bond Prices

Bond Prices and Market Rates

7% 9% 11%

_________________________________

Bond J $786.81 $674.80 $581.74

% chg. (+16.60%) (___%)

Bond K $1,213.19 $1,065.04 $940.25

% chg. (___%) (-11.72%)

_________________________________

The results above demonstrate that, all else equal, the price of the lower-
coupon bond changes more (in percentage terms) than the price of the higher-
coupon bond when market rates change.
1. Infosys CFO wishes to invest its excess cash available on an asset wishes to
determine the required rate of return on Asset X, which has a Beta of 1.5. The
risk free rate of return is 7%; the return on the market portfolio of assets is 11%.
a. Based on the above information compute the expected return from Asset
X.
b. Suppose inflationary expectation changes from 7% to 10%, what is the
expected return from the asset X
c. Suppose due to some macroeconomic events, investors are more risk
averse causing a new market return of 14%. Compute the expected return
from the Asset X for the Infosys CFO in the given scenario.

2. Suppose the expected return from Asset A and B are 15% and 20% and corresponding standard
deviation are 20% and 30% respectively. The correlation coefficient of these two assets return is
computed to be 0.5. Given this information compute the minimum variance portfolio weights
for both of the assets, portfolio return and standard deviation.

A B
Return 15 20
STDEV 20 30
Correlation 0.5

Min Var
WA 0.857143
WB 0.142857
Return 15.71429 G15*D6+G16*E6
P STDEV 19.63961 (G15^2*D7^2+G16^2*E7^2+2*G15*G16*D7*E7*E8)^0.5

3. Suppose the risk free rate is 5% and the S&P 500 index return is 12%. M&M stock
returns are 20% less volatile than the market. Compute the expected rate of
return from the M&M stock.
4. Suppose the dividend of a super normal growth firm are expected to grow at 30% for 3 years
and afterwards the growth rate falls to 10% rest of the periods FOR REST OF THE LIFE OF THE
COMPANY. If the stockholders required rate of return is 16% and the last dividend paid by
 company was $1.82. Estimate the present value of such a non-constant (supernormal) growth
company.
5. Q7. Multi-Products Ltd has been following a dividend payout of only 20% so that the funds
needed for the growth of the firm targeted at 10% is retained. The market expectations of
return are 12%.
a. (a) At what rate the market is discounting the current and future earnings of Multi-
Products Ltd?
b. (b) If the current level of earnings is Rs.10 per share at what price the shares of the firm
are being traded?

Section C

1. Theta Ltd is a privately held company that has been doing wonderfully well
.It has bagged prestigious contracts for supply of electrical transformers
from several electricity boards in India. The current level of profitability of
Theta Ltd is Rs.12 per share. In order to execute the orders of the electricity
boards, it needs to mobilize capital from the capital markets by issuing fresh
shares. The merchant bankers appointed for the purpose of mobilising fresh
capital have gathered information about the P/E ratios of major companies in
order to price the issue of shares. The P/E multiples of 4 major firms (based
on the latest price expected future earnings) in the same line of business of el
goods, as below:
 Firm A Firm B Firm C Firm

P/E multiple 10.2 12.4 13.5 18.6

The management of the company expects that on the enhanced capital of the firm
and upon successful execution on orders on hand the expected earnings level
would rise from current level of Rs.12 to Rs.14 per share, which is not disputed.
The Chairman of Theta Ltd thought that his firm is in no way inferior to the market
leader Firm D and therefore must command the same valuation from the market.
On the other hand, CFO of the firm thought that the firm being relatively unknown
to the potential investors it would be able to attract valuation no greater that of
Firm A. The merchant banker caught in the dilemma of pricing the issue tried to
resolve by proposing that the price of the issue be done on the basis of average of
the valuation for the industry and regarded the four firms as adequate
representative sample.

Find out at what price the public offer of Theta Ltd be made according to the (a)
Chairman, (b) CFO, and (c) Merchant bankers?

Q2. Suppose you wish to estimate the value of three assets you are considering
investing in a common stock of Infosys, a Godavari Basin Oil well and an original
MF Hussein’s painting. You expect to receive cash dividends of Rs. 300 per year
indefinitely from the investment in Infosys stock, where prevailing discounting
factor is 12% per annum. You also expect to receive cash flow of Rs. 2000 at the
end of the 1st year, Rs. 4000 at the end of the 2nd year and Rs. 10000 at the end of
the 4th year, when the oil well is to be sold, where prevailing discount factor for
the oil business is 20%. Investing in painting you consider two different scenarios.
First, now you got a major call from the Mumbai Art Gallery, who wants to buy
the painting at Rs.85000 at the end of 5th year, which is considered to be certain in
your view and can provide you 9% annual return. Second, you examined from the
previous transactions that the value of the MF Hussein’s painting value has
fluctuated widely over the past 10 years. Although you expect to sale the painting
at Rs. 85000, still you realize that its sale price in five years’ time could range
between Rs. 60500 and Rs. 1,55,000 because of this high uncertainty you believe
that 15% required return is appropriate to make investment in this asset. Given the
above information, can you value these three assets using standard discounting
principle and recommend the values at which you are proposing to invest in? Go
ahead with the further assumption which may help you to solve the problem.