Financial Instruments and Markets - Assignment Example

Valuation of securities Student’s name Institution Introduction A market is a place where goods and services are exchanged at a profit. It is where buying and selling takes place. The two main categories of markets are the primary and the secondary markets. There various types of markets which are the goods market, security market, capital market and the money market (Bond & Brown, 2002). In the security market, securities such as shares and bonds are traded where the security holders sell security at higher prices than the face value so as to earn profits. Individuals buy securities when the interest rates are low and sell them when the interest rates are high (Valdez & Wood, 2003). Difference between primary and a secondary market A primary market is where securities such as bonds or shares are sold by the firm to the public for the first time. In this market there is no reselling of the securities but individuals purchase them direct from the firm. Secondary market of the other hand is where securities are resold after the initial offer from the company (Bridwell, 2012). It is where investors buy securities from other investors where they pay a higher price than the initial price offered by the company. Investors usually buy securities at times when the interest rates are low and sell them when the rates arise. Primary markets collect funds directly from the public where securities are offered to the public. Secondary markets obtain funds from other investors who repurchase securities from them the secondary markets (Fabozzi, 2001). The three main forms of market efficiency under the EMH Strong-form EMH The efficient market hypothesis in its strong form states that for a market to be efficient, all the essential information towards the share value should be accurate and quickly reflected to the market prices. A good example is where the prevailed market price is lower justified value through some information. Those with the knowledge of the justified value will utilize the opportunity by buying more shares (Levinson, 2006). The process will continue raising the demand, until where the price of the share is raised up to the value justified through the private information. At this point, such buyers withdraw from the market leaving the market settling at the new equilibrium point of higher price. This is the strong- form efficient market hypothesis (Loss, 1988) Semi-strong-form EMH In the semi- strong efficient market hypothesis, a market is said to be efficient if all the essential available information is reflected quickly to the market prices. Here, the market fast grasp the significant new information by rising the price to a higher equilibrium point that shows the changes in demand and supply contributed by the emergence of the information (Elliot & Kopp, 2000). Weak-form EMH In this form of efficient market hypothesis, the new value of a share is derived by comparing the new information with the previous information. Comparing the two is when a new share price is determined. Here the new share price is normally higher than the previous share price (Bond & Brown, 2002). Among the three forms of market efficiency, the strong form efficient market hypothesis will have the best superannuation at retirement. Since individuals respond quickly to the market prices on the basis of private information, the share price keeps on rising up to a point where it settles at a higher equilibrium point. When an individual retires, he or she becomes advantaged in that he or she can sell the shares at a higher price than the initial buying price (Loss, 1988). Question 4 Calculating the terminal value of a superannuation scheme with defined contributions of $500 per month, continuing for 40 years, if average returns are 9 per cent per annum* for the first 30 years but unfortunately decline to just 3 per cent per annum* for the final 10 years. The terminal value of a superannuation scheme Terminal value is the value of an asset at the end of its useful period. The terminal value of a superannuation scheme can be calculated as follows Contributions $500 per month/ $6000 per year Time 40 years Rate of return 9% per annum for the first 30 years 3% per annum for the remaining 10 years Terminal value= monthly contribution + the return The terminal value is $ 1,329,073.06 Question five The face value is the value of shares a company issues to the public for the first time. The price of such shares is usually low than when a company or an individual resells the share. Interest is normally charged where the company or individual selling the share earns some profits. The earlier one pays back the face value, less interest one pays (Bond, & Brown, 2002). A good example is the following scenario; Face value = $5000000 Time 90 days/ 3 months Interest 90 BBSW 4.3% at the time of issue (A). The fund manager who purchases the bills at the primary market will pay as follows Interest =F.V x time x discount rate I=$ 5000000 x 3/12 x 4.3/100 I= $ 53750 Buying price = I+FV = 53750+5000000 =$ 5, 053750 The fund manager will buy the bills at $5, 053750 (B). How much the company will receive The company will receive the face value plus the interest payment which is $5, 053750 Question 6 Yield is the total return on a security such as a bond. Yield = coupon amount/price Buying price = $5000000 x 3/12 x 4.75% = $ 59375 Selling price = $ 5000000 x 0.0972 x 4.92% = $ 23916.7 Yield = $ 59375  $ 23916.7 = $ 35458.3 Question 7 Treasury Bonds are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security, payable six monthly. All Treasury Bonds are exempt from non-resident interest withholding tax. The 4.50% April 2020 Treasury bond has a face value of $ 20,397, 000,000 Settlement price = F.V (1+r)-n = 20,397,000,000 x (1+ 0.055)-8 = $13331372549 Question 8 Holding period yield = time to maturity x coupon payments Coupon reinvested. Time to maturity = 10 Coupon payments =12% Coupon reinvested =4% Holding period yield = 10 x0.12 0.04 =30 The holding period yield is 30 years. Question 9 A share is the prevailing market value of a security. It is among the large sources of funds. An individual who purchases shares from a company becomes a share holder of that company in that he or she owns it and have a right to be informed of anything that affects the company through the annual general meeting (Levinson, 2006). The two main types of shares are the preference and the equity shares. Shareholders would prefer buying each of them due to the characteristics they posse Share of profit a shareholder earns when the company makes profits within a certain period. In case where the company runs at a loss, no divided can be paid to the shareholders (Loss, 1988). Price to earnings ratio (P/E ratio) is calculated by dividing the stock price with the earnings per share. P/E= Price/ EPS Projected price= EPS X P/E Company Price EPS P/E ratio Projected EPS Projected Price ANZ 23.37 1.73  13.51 2.00  23.37 CBA 51.86 3.51  14.77 3.30  51.84 NAB 25.02 1.92  13.03 2.30  25.02 Westpac 23.73 2.14  11.09 1.79  23.73 Question 10 Market depth information for Fosters Group Ltd: Buy   Sell Number Quantity Price # Price Quantity Number 4 5 400 5.730 1 5.770 1 200 1 2 2 360 5.720 2 5.780 6 750 1 1 900 5.710 3 5.790 1 445 2 2 4 780 5.700 4 5.800 7 678 3 1 5 000 5.680 5 5.810 500 1 (A). the outcome when an individual places an at order to sell 3000 fosters shares According to the above table, the first amount of foster shares that a seller can sell is 1200 shares at a price of 5.770. if one places an order to sell 3000 shares, he or she will first sell the first bunch of 1200 shares at the low price 5.770 and the remaining 1800 at a higher price 5.780. In this way, the seller will be advantaged in that he or she will make much profit. (B) How much I would pay to buy 5000 fosters shares In buying 5000 foster shares would first buy the bunch where the price of a share is 5.73 For the 5000 shares; 5000 x 5.73 = 28650 I would pay 28, 650 (C) After the transactions (a) and (b), the remaining transactions will of low prices where the price keeps on decreasing. As he number of transactions continues, the order queue will also continue increasing since individuals will want to purchase the shares at a low price. The demand for foster shares will keep on increasing. (D) Assuming transactions (a) and (b) do not take place, if I want to sell my 1500 foster shares at $5.78, less people will be willing to buy the shares. This is because; individuals are aware of the low price shares and can opt to buy the shares in bits. A one can first buy the 1200 foster shares at the low price and then the remaining 300 shares at the higher price. In this way the buyer will have minimizes the total cost. Conclusion According to the above explanations and calculations, it can be concluded that the most types of securities traded in the financial markets are bonds and shares. Human beings remain to be rationale since even in the financial markets, security buyers tend to minimize expenditure by bussing securities when the price is low and sellers selling more of their securities when the price is high. However there is a relationship between the stock or share price, earnings per share, price earnings ratio, projected earnings per share and the projected share price which are really helpful to individuals in making decision concerning the buying or selling of shares. References Bond, P. H., & Brown, P. K. (2002). Rating valuation: principles and practice. London: Estates Gazette. Bridwell, N. (2012). Clifford shares. New York, N.Y.: Scholastic. Elliott, R. J., & Kopp, P. E. (2000). Mathematics of financial markets. New York: Springer. Fabozzi, F. J. (2001). The handbook of fixed income securities (6th ed.). New York: McGraw Hill. Levinson, M. (2006). Guide to financial markets (4th ed.). London: Profile. Loss, L. (1988). Fundamentals of securities regulation (2nd ed.). Boston: Little, Brown. Valdez, S., & Wood, J. (2003). An introduction to global financial markets (4th ed.). Houndmills, Basingstoke, Hampshire: Palgrave Macmillan. Read More