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**Question 1**

The dividends and earnings of Company ABC are expected to grow as follows:

– 20 percent a year for the next 10 years

– 15 percent growth for another five years

– 3 percent (constantly) after the 15 years

The risk-free rate is 5 percent and the expected return on the market is 10 percent.

The Beta for Company ABC is 0.8 , and its current dividend is $1.55.

1. Calculate the required return using the CAPM. Briefly explain what the required return is.

[10/40]

2. The Dividend Discount Model (DDM) is commonly implemented to estimate the value of a

firm. There are three key cases of the DDM. Discuss these in a paragraph of 100 words. [10/40]

3. Calculate the dollar dividend for the first 15 years and their present value. Explain the choice

of the DDM case(s) implemented. [10/40]

4. Calculate the price of the stock at the beginning of Year 15. [5/40]

5. Calculate the PV of all dividends and their price.[5/40]

[Total marks for Question 1: 40/100]

**Question 2**

In his paper ‘Has finance made the world riskier’, Raguram Rajan states that:

“While the collection of data on the growth of the credit derivatives and credit default

swaps in the last several years is still in early stages and probably underestimates their

usage, the takeoff of this market is a testament to how financial innovation has been

used to spread traditional risks”

In an essay of 600 words or less, critically appraise how this relates to the use of derivatives and

discuss whether and to what extent you agree or disagree.

[Total marks for Question 2: 20/100]

**Question 3**

a. Explain what an inverted yield curve for a Treasury Bond means and why it is a relatively

rare phenomenon (100 words). [ 10/40]

b. Visit the website of the Federal Reserve Bank of St. Louis and observe the graph of a

10-Year Treasury Constant Maturity minus 2 – Year Treasury Constant Maturity for the last 10

years and comment on the direction of the yield curve since the start of the pandemic (early

2019) until today (early 2022). Critically discuss how the direction of the yield curve indicates the

status of the economy (recession, expansion) during this time. (400 words)

[Marks: 30/40]

c. Suppose that you are considering three alternative investments in bonds. The bonds have

different times to maturity, but carry the same default risk. You would like to gain an impression

of the extent of price volatility for each given alternative change in future interest rates.

The investments are:

● A two-year bond with an annual coupon of 6%, par value of £100 and the next coupon

payment in one year. The current yield to maturity on this bond is 6.5%.

● A ten-year bond with an annual coupon of 6%, par value of £100 and the next coupon

payment in one year. The current yield to maturity on this bond is 7.2%.

● A 20-year bond with an annual coupon of 6%, par value of £100 and the next coupon

payment in one year. The current yield to maturity on this bond is 7.7%.

Given the above information, answer the following:

ii) Calculate the price of each of these bonds. [2.5/20]

iii) Calculate the price of each of these bonds on the assumption that yields to maturity rise by

200 basis points. Comment on the results. [5/20]

iv) Calculate the price of each of these bonds on the assumption that yields to maturity fall by

200 basis points. Comment on the results. [5/20]

v) Explain briefly which bond price is the most volatile in circumstances of changing yields to

maturity?[5/20]

vi) In a short paragraph of 100 words explain what bond duration is and how it differs from time

to maturity. [5/20]

[Marks: 20/40]

[Total marks for Question 3: 40/100