FINANCIAL ANALYSIS

Financial Analysis

Financial Analysis

Question 1

(a)

Portfolio A

Expected return = ? (Annual return * Probability) = (0.015 * 0.05) + (0.06* 0.65) + (0.12*0.30)

= 0.075 or 7.5%

Standard deviation = v? (Expected return - Mean expected return) 2 * Probability = v (0.015-0.075) 2 * 0.05 + (0.06-0.075)2 * 0.65 + (0.12-0.075)2 * 0.30

= v0.000934

= 0.030557 or 3%

Hence 3% of the returns of portfolio A are deviating from the mean return.

Portfolio B

Expected return = ? (Annual return * Probability)

= (0.02 * 0.15) + (0.75 * 0.45) + (0.18 * .40)

= 0.1087 or 10.87%

Standard deviation = v? (Expected return - Mean expected return) 2 * Probability

= v (0.02-0.1087) 2 * 0.15 + (0.075-0.1087)2 * 0.45 + (0.18-0.1087)2 * 0.40

= v 0.003725

= 0.061 or 6.1%

Hence 6% of the returns of portfolio A are deviating from the mean return.

 

Portfolio A

Portfolio B

Expected return

7.50%

10.87%

Standard deviation

3%

6%

We can see from the calculation above that two portfolios vary in their risk and return characteristics. Portfolio A has lower expected return than portfolio B but also has the lower volatility of returns. On the other hand portfolio B has both higher standard deviation as well as return. The decision to choose what portfolio depends upon the degree of risk aversion of Bizno Plc. If Bizno Plc is risk averse, the portfolio A is the better choice and if it is risk neutral or risk taker, then it will undertake portfolio B because of its high return.

(b)

A zero coupon bond is one which pays no coupon payments or interests after periodic intervals rather the bond is issued at a discount and the redemption is done at par value (Choudhry, 2006, pp.1). Yield to maturity of a zero coupon bond is calculated as under

Zero coupon bond value = future value / (1+YTM) n

By using this formula we can find the YTM of all the five bonds as under

PV of bond 1 = FV / (1+YTM) 1

972.76 = 1000 / (1+YTM)

1+YTM = 1.028

YTM = 0.028 or 2.8%

PV of bond 2 = FV / (1+YTM) 2

933.51 = 1000/ (1+YTM) 2

YTM = 0.035 or 3.5%

PV of bond 3 = FV / (1+YTM) 3

876.28 = 1000/ (1+YTM) 3

YTM = .045 or 4.5%

PV of bond 4 = FV/ (1+YTM) 4

850.65 = 1000/ (1+YTM) 4

YTM = 0.038 or 3.8%

PV of bond 5 = FV/ (1+YTM) 5

837.90 = 1000/ (1+YTM) 5

YTM = 0.036 or 3.6%

 

Bond 1

Bond 2

Bond 3

Bond 4

Bond 5

YTM

2.80%

3.50%

4.50%

3.80%

3.60%

The graph depicting a relationship between a bond yield and it's time to maturity is known as yield curve.

The graph shows the yileds on hih end of the curve are lower than the low end of the curve. Yileds for the first three years are increaing and then the yields are on the decline. This type of curve is known as inverted yield curve. Normally the longer the term to maturity, the higher are the yields (Wiener, 2012, ...