11 May EXPLAIN HOW EACH OF THE INVESTMENTS MIGHT BE EXPOSED TO THE THREE HIGH-LEVEL RISKS: CAPITAL RISK, INCOME RISK, AND LIQUIDITY RISK.
Sam receives two payments of £100: one payment today and the other next year. Explain which of these payments he is likely to regard as having the highest value, and give two reasons why. Explain, using the concept of a discount rate, how Sam might be compensated to ensure that he views the payments as having the same value. (10 marks)
b.An investor is faced with three possible choices, collated in Table 1 below. Using the Investment Tool (Present value & discount rate segment), calculate the rate of return from each investment product. Explain the figures you have entered in the Investment Tool, and explain which is the most attractive investment opportunity. (20 marks)
c.Using the Investment Tool (Present value & discount rate segment), calculate the rate of return on the government bonds if the annual coupon was instead set at 6 per cent. Explain how this adjustment might induce a change in your choice of which investment product is the most attractive opportunity. (10 marks)
d.Identify two risks that might be associated with saving money in an instant access bank account. (10 marks)
Three investment products for rate of return calculations Table 1
Product 1 Shares in Chemcon, purchased at a current price of £14 per share, paying four equal dividends a year of 20p each. The shares will be held for twelve years, after which they are expected to be sold at a higher price of £16 per share
Product 2 Government bonds with an annual coupon of 10 per cent, purchased at a current price of £108 for each £100 nominal to be held until redemption after nine years. The coupon is paid each year in two half-yearly instalments
Product 3 Corporate bonds with an annual coupon of 6 per cent, purchased at a current price of £115 for each £100 nominal to be held until redemption after five years. The coupon is paid each year in one instalment
Question 2
Table 2 below shows five alternative ways to invest a £100,000 lump sum. Explain how each of the investments might be exposed to the three high-level risks: capital risk, income risk, and liquidity risk. Discuss how your assessment of each investment might change if the expected inflation rate increased from 1 per cent to 4 per cent a year. (50 marks)
Alternative ways of investing a £100,000 lump sum Table 2
Investment Key facts
Safesave
5-year fixed-term savings account with the UK branch of the Bank of Kwancheng
Interest rate: 4% a year
From the bank’s income statement: proportion of total bank income from net interest = 27%
Gilt: 5% Treasury 2030
Government bond with a redemption date of 2030
Redemption yield: 5% a year
Sleeplux shares
Shares in an established luxury bed retailer, listed on the London Stock Exchange
Average dividend yield: 4% a year; average expected value: 6% a year
Standard deviation of annualised expected value: 11%
Electrobook shares
Shares in an electronic book publisher, listed on the New York Stock Exchange
No dividend yet. Expected value 8% pa (might pay dividend later). Standard deviation of annualised expected value: 21%
Dorset Holiday Home Holiday rental in the Dorset countryside. Purchase price £400,000; mortgage obtained for £300,000 over 25 years at 5% variable interest; return from lettings expected to average 10% a year, assuming the property is sold at the end of the mortgage term at a profit
In the following sections you will find:
learning outcomes addressed by this assignment
student notes for each part of this assignment
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