Problem 8. A large mutual fund is investigating the market to include new assets into its investment portfolio. There are several options available: Orio: a bond package of a well-established company with high revenues and stable payouts. The data on the bond are the following its return is 5% lower than the required return on equity of this company, Coupon rate is 8% and coupons are paid semiannually. Only 2 years are left till maturity. Oniowa share package of the same company. The shares are traded on the LSE and you have summarized information about the UK financial market in the table below. Correlation of returns between the market and the company is 0,6. The standard deviation of returns for the company is 10%. The dividend per share has been fixed by top – management 3 years apo at the level of 45 and analysts do not have any reasons to assume that this amount will be changed. Instrument Price (to) Price (L1) Standard deviation,% FTSE 6505£ UK govt 105£ 101£ bonds (gilts) 7416 a) Describe the process of bond valuation specifically stating the parameters that are necessary to calculate the price in practice. (5 points) b) Calculate the bond price. (3 points) e) Describe the two main types of risks that are inherent in every stock. Illustrate graphically and mathematically (4 points) d) Calculate the stock price justifying all the assumptions/ models that are used in your calculations. (5 points) e) Describe the value and size anomaly not captured by CAPM and describe the approach that can be used to capture both anomalies. (8 points)

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