) Ahmed is planning to buy new 20-year bonds. Initially, his plan was to invest in the non-callable bond. Then he is going to access the alternative, If the bond will have a call clause after 5 years of life with a 5% call premium, how would this affect the bond's required rate of return? Explain your point of view with respect to call provisioning.
a) Ahmed is planning to buy new 20-year bonds. Initially, his plan was to invest in the non-callable bond. Then he is going to access the alternative, If the bond will have a call clause after 5 years of life with a 5% call premium, how would this affect the bond's required
b) You are considering two bonds A and B; Bond A has a 9% annual coupon rate while Bond B has a 6% annual coupon payment. Both bonds have YTM of 7, which is expected to remain constant over their life of 7 years. What will be the price path of two bonds? Please explain it with respect to the graph of
c) A highly risk-averse investor is considering adding one additional stock to a 4-stock portfolio. Two stocks are under consideration. Both have an expected return,, of 15%. However, the distribution of possible returns associated with Stock A has a standard deviation of 12%, while Stock B’s standard deviation is 8%. Both stocks are equally highly correlated with the market, with correlation equal to 0.75 for both stocks. Which stock should this risk-averse, will add to his/her portfolio? Explain with reasoning
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1. Ahmed is planning to buy a non-callable bond that will fix his returns over the 20 year investment period, as the company can't call the bond.
2. If the company has a callable provision after a specified number of years at a premium of say x%, then it becomes a callable bond and the company can buy back the bond form the investors
3. Usually, callable provisions are inserted in the case of interest rates going down in the market. For example: If the bond is issued at 7% and now the interest rate in the market are 4%, then the company would benefit by buying back the bond and getting funds from the market at 4% rather than paying 7% to the existing bondholders
4. This exposes the risk of the investors of investing their money at lower interest rate once the bonds all called back
5. There is a call premium but it is only one time and usually doesn't compensate the losses face by the investors
6. Hence, due to this specific risk, the callable bonds interest rates are higher than noncallable bonds
7. Hence, the required rate of return of callable bonds is higher than noncallable bonds
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