An investment advisor has shown you two investments. Which investment would you

Question

An investment advisor has shown you two investments. Which investment would you recommend and why. Submit using a spreadsheet.

Bond: Coupon bond with a face value of $50,000 that can be purchased today for $48,000 that matures in 5 years. Its annual coupon rate is 9% and the coupon is paid semi-annually.

Stock: Shares of a stock can be purchased for $60 per share today. Its price of a stock is forecast to grow 8% annually for the next 5 years. (your first task is to compute the expected future price). It is expected to pay dividends of $2.00 semi-annually.

Explanation / Answer

Yield on Bond Face Value= $50000 Coupon= 9% paid semi annually Coupon every 6 months= 9%*50000*1/2= 2250 Time= 5 years No: of coupons= 5*2= 10 Yield= {I + [(F-P)/n]}/ [(F+P)/2] Yield= {2250 + [(50000-48000)/10]}/ [(50000+48000)/2] Hence, Yield= 5% Return on Stock Price today= 60 Price after 5 years= 60 * (1.08)^5= 88.16 Dividends= 2*(5*2)= 20 Return on stock= {[Change in Price + Dividend]/ Beginning Price}*100 Return on stock= {[(88.16-60) + 20]/ 60}*100= 80.27% Hence average return on stock= 80.27%/5= 16.05% As the return on stock is more as compared to yield on bond, investment in stock is advisable.

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